83518 Independent Evaluation of the IFC Secured Transactions Advisory Project in China NOVEMBER 12, 2011 PREPARED FOR THE INTERNATIONAL FINANCE CORPORATION COPENHAGEN | DAKAR | GENEVA | JOHANNESBURG | LONDON | MUMBAI | NAIROBI | NEW YORK | SAN FRANCISCO | WASHINGTON DC This evaluation report was prepared by Dalberg Global Development Advisors (www.dalberg.com), an international development consulting firm. The Dalberg evaluation team included: Veronica Chau, Bruce Au, Lisa Lee, Ameya Bhangle, Jasmin Tsai and Michael Tsan. Jaouad Berrada of CIF Consultants served as an expert advisor and participated in the field mission. Technical translation was provided by Ming Li of IFC. The survey of Financial Institutions was conducted by the Research Institute of Finance and Banking, People’s Bank of China (Research Institute, PBOC), led by Shaohua Zhang. The survey of SMEs was completed by China Mainland Marketing Research Co. (CMMR). Extensive data was provided to the evaluation team from the People's Bank of China, Credit Reference Center. We would like to thank the many stakeholders who generously gave their time for interviews and surveys. We would also like to particularly thank the IFC staff who played leadership roles in this evaluation on behalf of IFC: Alejandro Alvarez de la Campa, Alexis Diamond, Jinchang Lai and Chaoying Liu. The evaluators are grateful for valuable contributions and feedback throughout the process by Hyun-Chan Cho, Wanjie Chen, Elaine MacEachern, Lin Huang, Matthew Gamser, Yifan Gao, Zhifang Luo, Jennifer Ann Lovell, Mingyu Ma, Peer Stein, Lory Camba Opem and Zhu Zheng. Dalberg Global Development Advisors Washington D.C. Office 1634 I St. NW, Suite 300 Washington, DC, 20006 USA Telephone: (+1) 202 659 6570 Telefax: (+1) 202 659 6863 Email: Veronica.Chau@dalberg.com (Lead Evaluator) Web site: www.dalberg.com 2 Contents Executive Summary ...................................................................................................................................................4 1 Scope and Methodology .................................................................................................................................10 2 Relevance........................................................................................................................................................16 2.1 Relevance to the intended beneficiary: SMEs .......................................................................................16 2.2 Relevance to IFC Strategy ......................................................................................................................17 2.3 Relevance to China and its Financial Institutions (FIs) ...........................................................................18 2.4 Relevance to Donors and Additionality in Development Community ...................................................20 3 Effectiveness ...................................................................................................................................................21 3.1 Development of a Law ...........................................................................................................................22 3.2 Development of a Security Interest Registry .........................................................................................24 3.3 Public Awareness and Capacity Building ...............................................................................................26 4 Impact .............................................................................................................................................................27 4.1 Theory of Change ...................................................................................................................................27 4.2 Emerging Movables Financing Sector ....................................................................................................29 4.2.1 Introduction ...........................................................................................................................................29 4.2.2 Trends in the overall movables financing sector as a whole .................................................................29 4.2.3 Insights on the adoption and practice of A/R financing ........................................................................34 4.3 SME Access to Finance ...........................................................................................................................38 4.3.1 Insights on breaking a barrier for SME financing ...................................................................................38 4.3.2 Insights on SME financing trends ...........................................................................................................43 4.3.3 The number and profile of SMEs that receive A/R financing .................................................................45 4.4 SME Business Performance ...................................................................................................................48 4.4.1 Case I: United MetalTek in Zhejiang ......................................................................................................50 4.4.2 Case II: Sichuan Tianyue Industry in Sichuan .........................................................................................53 4.4.3 Impact of movables financing on job creation ......................................................................................55 5 Efficiency .........................................................................................................................................................56 6 Sustainability ..................................................................................................................................................57 7 Replicability and Lessons Learned ..................................................................................................................58 8 Future Development of Movables Financing in China ....................................................................................63 Appendices...................................................................................................................................................................66 Appendix A: Financial Institution Case Studies ........................................................................................................66 Appendix B: Interview List .......................................................................................................................................76 Appendix C: Methodology and Summary Results of FI Survey ................................................................................79 Appendix D: Methodology and Summary Results of SME Survey..........................................................................101 Appendix E: Statistical Analysis of SME Survey .....................................................................................................117 Appendix F: Quality of the CRC Registry Data .......................................................................................................118 Appendix G: Definition of Small- and Medium-sized Enterprises ..........................................................................119 3 Table of Figures FIGURE 1.1 EVALUATION FRAMEWORK ............................................................................................................................................................................ 13 FIGURE 1.2 DETAILS ON DATA SOURCES USED IN THE EVALUATION ........................................................................................................................................ 14 FIGURE 2.1 SMES REGARD ACCESS TO FINANCING AS THEIR BIGGEST CONSTRAINT .................................................................................................................... 16 FIGURE 2.2 KEY DRIVERS FOR LACK OF SME ACCESS TO FINANCING ....................................................................................................................................... 17 FIGURE 2.3 INITIAL PUBLIC OFFERINGS OF LARGE COMMERCIAL BANKS IN CHINA ...................................................................................................................... 18 FIGURE 2.4 COMMERCIAL PRACTICE BENEFICIAL TO FIS IN CHINA .......................................................................................................................................... 19 FIGURE 3.1 ACHIEVEMENTS OF KEY PROJECT INDICATORS .................................................................................................................................................... 22 FIGURE 3.2 TIMELINE OF CHINA’S PROPERTY LAW REFORM ................................................................................................................................................. 23 FIGURE 3.3 MULTIPLE REGISTRATION SYSTEMS IN CHINA ..................................................................................................................................................... 25 FIGURE 3.4 SAMPLES OF PROJECT PUBLICATIONS IN CHINESE AND BOOKS THE PROJECT SUPPORTED............................................................................................. 27 FIGURE 4.1 THREE LEVELS OF THE PROJECT IMPACT ............................................................................................................................................................ 28 FIGURE 4.2 GROWTH OF COMMERCIAL LOAN PORTFOLIO SECURED BY EXCLUSIVELY MOVABLE ASSETS .......................................................................................... 30 FIGURE 4.3 COMMERCIAL LOAN PORTFOLIO SECURED BY MOVABLE ASSETS VS. OTHER FORMS OF ASSETS ...................................................................................... 31 FIGURE 4.4 PRODUCT INNOVATIONS IN MOVABLES FINANCING ............................................................................................................................................. 32 FIGURE 4.5 REASONS FOR THE INCREASED LENDING SECURED BY MOVABLE COLLATERAL AMONG SURVEYED FIS ............................................................................. 33 FIGURE 4.6 GROWTH IN THE NUMBER OF REGISTRATIONS OF A/R TRANSACTIONS .................................................................................................................... 35 FIGURE 4.7 INDICATORS OF MARKET ADOPTION OF A/R FINANCING IN CHINA ......................................................................................................................... 36 FIGURE 4.8 REASONS FOR NOT UTILIZING A/R AS SECURITY INTEREST .................................................................................................................................... 37 FIGURE 4.9 REASONS FOR NON-ACCEPTANCE OF A/R AS COLLATERAL—PERSPECTIVES FROM LENDERS AND BORROWERS ................................................................ 38 FIGURE 4.10 SME LENDING GROWTH AND ITS DRIVERS....................................................................................................................................................... 39 FIGURE 4.11 TIMING OF INCREASED FOCUS ON SME MARKET BY NATIONWIDE BANKS .............................................................................................................. 40 FIGURE 4.12 PERCEIVED IMPACT OF IFC PROJECT OUTCOMES .............................................................................................................................................. 41 FIGURE 4.13 PERCEIVED REASONS FOR UNSUCCESSFUL LOAN APPLICATIONS............................................................................................................................ 42 FIGURE 4.14 PERCEIVED IMPACT IF A/R LOANS WERE TAKEN AWAY ...................................................................................................................................... 42 FIGURE 4.15 LENDING TO SMES BY FORM OF ACCEPTABLE COLLATERAL ................................................................................................................................. 43 FIGURE 4.16 SECTORS MOST RELEVANT TO FI MOVABLE LENDING ......................................................................................................................................... 44 FIGURE 4.17 SAMPLE PRODUCT INNOVATIONS OF A/R FINANCING ........................................................................................................................................ 45 FIGURE 4.18 NUMBER OF REGISTERED A/R REGISTRATIONS AND SEARCHES ............................................................................................................................ 46 FIGURE 4.19 CHINA STATE STATISTICS BUREAU’S DEFINITIONE 31: ....................................................................................................................................... 47 FIGURE 4.20 PERCENTAGE OF ENTERPRISES CLASSIFIED AS SMES BY IFC PROXY DEFINITION ....................................................................................................... 47 FIGURE 4.21 GENERAL CHARACTERISTICS OF SMES BASED ON SURVEY RESULTS ....................................................................................................................... 48 FIGURE 4.22 BENEFITS OF A/R FINANCING ....................................................................................................................................................................... 49 FIGURE 5.1 EXPENSES, FUNDING SOURCES, AND BUDGET..................................................................................................................................................... 57 FIGURE 7.1 PROJECT TIMELINE (2003—2011)................................................................................................................................................................. 60 FIGURE 7.2 CHINA’S ECONOMY WAS IN A PERIOD OF HIGH GROWTH ...................................................................................................................................... 61 FIGURE 9.1 CHANGES IN VOLUME OF LENDING SECURED BY MOVABLE ASSETS, AS A SHARE OF THE TOTAL VOLUME OF LENDING ........................................................ 69 FIGURE 9.2 CHANGES IN SME LENDING ACTIVITY ............................................................................................................................................................... 70 FIGURE 9.3 CHANGES IN SME LENDING VOLUME ............................................................................................................................................................... 70 FIGURE 9.4 CHANGES IN VOLUME OF LENDING SECURED BY MOVABLE ASSETS, AS A SHARE OF THE TOTAL VOLUME OF LENDING ..................................................... 72 FIGURE 9.5 CHANGES IN NUMBER OF SME CLIENTS IN THE COMMERCIAL LOAN PORTFOLIO ...................................................................................................... 74 FIGURE 9.6 CHANGES IN VOLUME OF LENDING TO SME CLIENTS IN THE COMMERCIAL LOAN PORTFOLIO ..................................................................................... 75 FIGURE 10.1 CHINESE BANKING SECTOR (2006-2010) BY INSTITUTION TYPE .......................................................................................................................... 79 FIGURE 10.2 SAMPLE AND POPULATION SIZE OF THE FI SURVEY ............................................................................................................................................ 80 FIGURE 11.1 CITIES WHERE THE SME SURVEY WAS CONDUCTED......................................................................................................................................... 101 FIGURE 11.2 REASONS OF LOW SUCCESS RATE FOR THE SME SURVEY .................................................................................................................................. 102 FIGURE 11.3 SME SIZE .............................................................................................................................................................................................. 102 FIGURE 11.4 SME SAMPLE STRATIFICATION ................................................................................................................................................................... 103 FIGURE 12.1 DISCREPANCIES IN REGISTERING FINANCIAL VALUES IN CRC REGISTRY ................................................................................................................ 118 FIGURE 13.1 CHINESE DEFINITION OF MSMES ............................................................................................................................................................... 119 FIGURE 13.2 IFC DEFINITION FOR MSMES .................................................................................................................................................................... 120 4 Executive Summary This report is an evaluation of the IFC China Secured Transactions Project (the Project). The Project is an effort to advise People’s Bank of China (PBOC) on the development and rollout of a modern secured transactions system in the People’s Republic of China. The Project aims to facilitate the development of the Small and Medium Enterprise (SME) and financial sectors by assisting the Chinese government in learning and adopting the experiences of other economies, where movable assets are a major source of SME financing. Specific target outcomes of the Project include (1) development of a law, (2) development of a security interest registry, and (3) public awareness and capacity building. The Project implementation began in January 2004 and lasted until June 2011. The Investment Climate Department of the World Bank Group (former FIAS), IFC’s Project Development Facility (CPDF)1, and the State Secretariat for Economic Affairs of the Government of Switzerland (SECO) each provided financial support for the Project. This independent evaluation was commissioned by IFC to achieve the following objectives: 1. To evaluate the China Secured Transactions project and validate the results reported by the project team 2. To compare the design, approach, and methodology used in the China project with the overall approach of the Secured Transactions Program 3. To draw lessons learnt from the China Secured Transactions project and the overall program and provide recommendations on improvements and alternative approaches that the secured transactions program could employ going forward, including closer integration and collaboration with other existing IFC Access to Finance products The evaluation is based on extensive desk research, an in-country mission to interview key stakeholders, new surveys of 247 SMEs and 50 financial institutions (FIs), data from Credit Reference Center (CRC) Registry, and case studies of SMEs and FIs. Evaluation Findings The goal of enabling and promoting the use of movable assets as collateral was highly relevant from both the demand perspective (SMEs and FIs in China) and the supply perspective (IFC and donors). It addressed an important bottleneck to SME sector growth and focused on one of China’s major national development priorities. At the outset of the Project in 2003, FIs in China primarily accepted real property as security when lending to commercial enterprises. Less than 7% of their outstanding business credit was secured exclusively with movable assets, which at the time were mostly inventories and 1 Note: IFC created an Advisory Services Unit in China in 2002. Several names have been used successively for the Unit, including China Project Development Facility (CPDF), Private Enterprises Partnership (PEP-China) and IFC Advisory Services in China (IFC AS China). All these names refer to the same technical assistance (advisory) unit based in Chengdu, China. 5 equipment.2 In contrast, more than half the assets owned by Chinese SMEs were movable assets such as accounts receivable (A/R). The resulting lack of acceptable security collateral was the primary obstacle to SMEs obtaining more financing.3 The Project was very effective in achieving the intended outputs and outcomes. The Project has achieved all of its performance indicators with substantial over-performance on initial targets set. The legal and regulatory framework for secured transactions that was established incorporated international best practices. Many of those involved in the drafting of the law believe that the knowledge gained through the Project was a critical input in drafting the law. A single, unified electronic registry for A/R security interests was launched, featuring many policies and functionalities informed by the expertise offered by the Project team. A significant level of media coverage and awareness about movables financing has occurred, and as of July 2011, 61 awareness-raising events had occurred, with an attendance of 5,378 people4. Impact on the Chinese financial sector: The Project enabled significant innovation and growth of movables financing, particularly in A/R financing. In the first two full years (2008-2010) that followed the adoption of the Property Law and establishment of the A/R Registry, the total number of commercial loans involving movable assets5 grew by 21% per year and the value of loans grew by 24% per year. As a result of this growth, the composition of FIs’ lending portfolios in terms of the types of security interests is shifting. For example, the share of loans secured by movable financing among “Big 5” FIs rose from 27% in 2006 to 33% in 2010. 90% of the 50 FIs surveyed for this evaluation now engage in movables financing, and as of June 2011, the CRC reports that all 21 of China’s largest national banks are users of the Registry. As of June 2011, the Credit Reference Center (CRC) reported a cumulative amount of lending secured by A/R of USD 3.5 trillion, involving ~385,000 transactions6. However, the majority of these transactions are completed by larger banks. According to the survey of 50 FIs conducted for this evaluation, 14 local and smaller FIs had not yet adopted A/R financing. This is a significant finding because these FIs are important sources of finance for SMEs. This finding was validated further when reviewing the data from the CRC registry - local domestic banks represent only 7% of the total share of registrations in the CRC database. The key reasons cited by these FIs in the survey and interviews were a perception that A/R lending is higher risk, and gaps in technical expertise for developing new procedures for verifying and monitoring assets. The cumulative number of SME borrowers that were extended loans secured by A/Rs since October 2007 was 68,5757. According to the same data source, a cumulative amount of USD 1.09 trillion of 2 Source: People’s Bank of China (PBOC)-FIAS-CPDF survey of financial institutions (the “Lender Survey”), P.56. 3 Source: NDRC/PEP-China 2005/06 SME Finance Survey (1000 SMEs in Five Cities). 4 Source: IFC “Secured Transactions Training / Event Summary,” October 2011 5 These commercial loans include loans secured exclusively by movable assets as well as those secured by a combination of movable and immovable assets 6 Source: IFC Advisory Services Project Completion Report 521957, September 26, 2011 v 0.9 7 Source: IFC Advisory Services Project Completion Report 521957, September 26, 2011 v 0.9; Note that this number refers only to “incorporated SMEs" (legal persons). This number excludes users th at are not considered to 6 finance secured by A/Rs has been extended to SMEs8. The note of caution with these figures is that they are based on data that is self-reported by FIs, using a definition of SME that is larger than it is in many other regions in the world. The CRC does not verify if the data is consistently entered in accordance with these national guidelines9. Impact on SME lending by FIs: the Project facilitated strong growth in SME lending by banks. 4 of the Big 5 banks reported an average 25% CAGR for SME lending in 2008-2010, up from 2% in 2006-2008 periods. Seven other large commercial banks reported an average of 45%. While there were several contributing factors to this growth in financing, FIs stated in the survey completed for this evaluation that the increase in access to finance for SMEs, particularly those that the FIs were not previously serving, was the most important impact of the Passage of 2007 Property Law. The introduction of movables financing in some cases triggered an overall improvement in the risk management practices of the FIs. For example, FIs reported that the increased awareness and focus on secured transactions lending contributed to an overall strengthening of risk management practices. Some of the larger FIs interviewed reported that they use movables financing as a way of mitigating the risks of lending to SMEs because of the increased access to business performance data that is enabled through lending on the basis of A/R. Impact on SMEs: the increased access to finance associated with the Project was highly valued by entrepreneurs leading SMES. In a survey of 250 entrepreneurs, when asked about challenges obtaining financing, “unacceptable collateral” was cited as their key concern. Of the 121 SMEs that were surveyed that were successful in obtaining a loan using movables, 59% of respondents stated that that their business would have been severely impacted, or worse, had they not had access to those loans. In the same survey, 88% of respondents indicated that business growth was a benefit that resulted from obtaining A/R financing. This study also found that female entrepreneurs are among the key beneficiaries of the Project. 63% of the SMEs in the survey that had used A/R to finance their loans had female ownership, and 20% were majority owned by women. In comparison, 14% of the enterprises in the sample of SMEs that did use A/R were majority owned by women. The Project achieved additionality; it provided unique support to Chinese government authorities and also filled a unique gap in financial sector interventions. Today the Project is the only donor or multinational development agency intervention that has remained focused on secured transactions reform in China. Stakeholder interviews and desk research also revealed that the Project’s comprehensive, specific, and “on-demand” advice has set it apart from other development agencies and donors that provide financial sector reform support and technical assistance. be “incorporated SMEs” but actually are smaller enterprises such as smallholder farmers or Public Service Units. This number is also likely to exclude SMEs that took out loans of relatively smaller transaction sizes as some lenders tend to only register transactions above a certain threshold. 8 Source: IFC Advisory Services Project Completion Report 521957, September 26, 2011 v 0.9 9 The Chinese Statistics Bureau provides sector-specific guidelines on how to classify a business, on the basis of number of employees, annual turnover and total assets 7 The Project was remarkably efficient in facilitating an increase of movables financing in China, due in part to the large size of the country’s economy. The Project has spent USD 1,539,168 since inception, but the amount of financing facilitated in China is much greater. For example, approximately USD 3.5 trillion of A/R financing has been registered between October 2007 and the end of June in 2011. This number, however, should be interpreted in the context of the size of China’s overall economy. Similar projects in other countries cannot be expected to achieve similar results. The Project’s outcomes—(1) development of a law, (2) development of a security interest registry, and (3) public awareness and capacity building—are expected to be highly sustainable in the future. They are likely to endure as the Chinese government and the banking sector continue to modernize the secured transactions system in China. Stakeholders in the Chinese government see no signs of any reversal of the Property Law of 2007. The Credit Reference Center (CRC), which hosts the newly established security interest registry, also shows no signs of facing any financial and operational difficulties. A new small flat fee for its registration services, imposed in early 2011, will also support the ongoing financial viability of the registry. Lessons Learned for Future Projects Four replicable lessons for IFC’s global secured transactions program identified . Based on the Project team’s reflections, they are (1) partnering with a politically powerful agency with market knowledge and administrative capacity, (2) positioning the reform as the creation of a market, (3) merging local knowledge with global subject-matter expertise, and (4) sustaining a professional team over time. The Project has also benefited from unprecedented levels of growth and development in the broader Chinese economy. IFC has to bear greater risks when launching a project in a less favorable macroeconomic environment. Four areas of potential improvement regarding the Project’s M&E design highlighted. Future projects should consider (1) enabling the host of a security interest registry to collect and disseminate statistics; (2) measuring the “credit culture” of FIs as a project outcome as well as establishing baseline credit culture specific to a country and using it to guide the content and target outcomes of their capacity building effort; (3) measuring the impact of a secured transactions program by tracking changes in a group of SMEs and banks over time; and (4) opportunistically measuring the impact on SME survival in times of liquidity crunch, such as bankruptcy rates and potential jobs saved, when applicable. Further Reforms to Movables Financing System in China Opportunities for FIs and government authorities to facilitate capital deepening and greater product sophistication. Through interviews with stakeholders and review of best practices, some further steps were identified that would enable movables financing to develop further. Some of the regulations associated with movables financing such as priority rights in more complex situations and procedures for claims enforcement require further clarification. There are opportunities to build on the success of the A/R Registry by improving and potentially merging registries for equipments and inventories. There 8 is also room for further strengthening of the service sector that supports movables financing such as third party firms that specialize in monitoring assets, and related “market infrastructure” building that would reduce the transaction costs associated with movables lending. The evaluation has demonstrated that significant progress has been made towards advancing the movables financing sector in China in a relatively short amount of time, especially in light of the complexity of the Chinese financial sector. However, when comparing where China is today to other countries with more developed movable financing sectors, it is apparent that there are still several important steps to be taken. Such steps include providing more clear Judicial Interpretations on Chapter IV of the Property Law and consolidating the Administration for Industry and Commerce (AIC) registries. While strong gains have been made by larger FIs, there are still opportunities to promote adoption of movables financing by smaller FIs through further awareness raising and technical assistance. Survey results of SMEs also point to an opportunity to raise awareness of movables financing among the business community. 9 1 Scope and Methodology The Project aimed to increase access to finance for firms, especially SMEs, by developing an appropriate legal and regulatory framework that allows and facilitates the use of movable assets as collateral for commercial loans10. The Project team has been advising PBOC on the development of a modern secured transactions system in China. It unofficially began in July 200311 when IFC first made contact with PBOC. It includes two sub-projects (521957 and 539924). One sub-project closed on June 30, 2009, while the other ended on June 30, 2011. Investment Climate Department of the World Bank Group (former FIAS), IFC’s Project Development Facility (CPDF)12 and the State Secretariat for Economic Affairs of the Government of Switzerland (SECO) provided financial support. The objectives of the project, as stated in the Project Approval Document, were as follows: “Expand access to business credit and encourage private sector growth by supporting the development of China’s new secured transactions law and institutions. More specifically, the project aims to  Expand and deepen awareness of best practices in secured transactions in order to build support for reforms;  Improve the commercial orientation of China’s secured transactions laws through legislative drafting support; and  13 Support the development of a pilot registry for security interests in A/R” These objectives were updated in 2008 to also include: “After the enactment of the Property Law in 2007, the FIAS-PEP China team will continue to support the Chinese government in the following areas to ensure implementation of the Law: (1) continue supporting the pilot for receivable registry and ensure that operations run smoothly (2) continue to undertake education and awareness-building campaigns, particularly to train the managers and staff of lending institutions in evaluating and perfecting movable security; (3) work with the Supreme Court to prepare the 14 Judicial Interpretation on secured transactions part of the property law.” 10 Source: Terms of Reference. 11 Source: IFC. 12 Note: IFC created an Advisory Services Unit in China in 2002. Several names have been used successively for the Unit, including China Project Development Facility (CPDF), Private Enterprises Partnership (PEP-China) and IFC Advisory Services in China (IFC AS China). All these names refer to the same technical assistance (advisory) unit based in Chengdu, China. 13 “Advisory Services Project Completion Report for Project ID 53994,” IFC, June 30, 2009 14 “Advisory Services Project Completion Report for Project ID 53994,” IFC, June 30, 2009 10 The intended activities and associated results of the project were listed in a logic model in the original project approval documentation. A copy of this original logic model appears below15: Expected Project Expected Outputs Expected Outcomes Expected Impact Components/Activities Ongoing dialogues with Answers to their A modern secured More and low-cost drafters of China’s secured questions, comments to transactions law and lending secured by transactions law the property law. supporting system movable assets Awareness-raising campaigns Various forms of Active participation by awareness raising events, stakeholders; exposure to including seminars, the best practice by symposiums, and stakeholders. conferences. Study and survey of secured Publications on final The appreciation of the transactions in China reports policy recommendations by stakeholders To assist the NPC-LAC to Comments to the law; Legislators understand the International best incorporate best practice Answers to their best practice and the practice was elements into the draft questions; Chinese context adopted in the law, Property Law until the expanding the legislation is successfully Provision of best practice scope for movable passed; materials financing Set up a registry pilot for Workshop on registry Proposition was well Pilot registry was receivable security based on development; proposition received; set up and modern secured transactions of modality on the Directives/regulation issued operational, registry principles establishment of pilot enabling receivable registry filing. Continue to undertake Training workshops were Training was well received, The volume of education and awareness- held Chinese banks obtain basic movable financing building campaigns, idea of how to do movable increased and SMEs particularly to train the financing, and start to had better access managers and staff of lending develop movable financing to finance. institutions in evaluating and perfecting movable security The evaluation is meant to address the following three objectives: 1. Evaluate the China Secured Transactions project and validate the results reported by the project team 2. Compare the design, approach, and methodology used in the China project with the overall approach of the Secured Transactions Program 15 “Advisory Services Project Approval Document for Project ID 53994,” IFC, October, 2008 11 3. Draw lessons learnt from the China Secured Transactions project and the overall program and provide recommendations on improvements and/or alternative approaches that the secured transactions program could employ going forward, including closer integration or collaboration with other existing IFC Access to Finance products The dimensions of the evaluation are as follows: 1. Relevance: The extent to which the project was aligned with the priorities of each of the key stakeholders, namely, China Secured Transactions project clients (e.g., People’s Bank of China), FIs, SMEs, IFC, and Donors. 2. Effectiveness: Review and validation of the extent to which target outputs and outcomes were realized. The evaluation team has checked the internal consistency for the measurement and calculation of the project’s outcomes and impacts based on document review and expert interviews. This analysis considers the elements of the project design that were critical to the project’s success and synthesizes learning for future projects. Other considerations included client satisfaction with services delivered, stakeholder perceptions of IFC’s additionality, and potential areas for improvement. Short of an experimental M&E design, this evaluation attempts to triangulate the degree to which the project contributed to the achievements of these outcomes and impacts based on multiple sources. 3. Impact at the FI and SME level: Through a new survey to collect primary data, this evaluation provides new evidence of the extent to which FIs have adopted movable financing and how this adoption has translated into improved access to finance for SMEs. At the SME level, we consider the extent to which the increased access to financing has translated into impact on their business performance. 4. Efficiency: This dimension considers the extent to which the program was executed in a cost- effective manner, taking into account plausible alternatives and opportunity costs. It also includes a review of the extent the project overlaps with similar programs supported by the development community or within IFC, and if the overlap is positive (e.g., potential for synergy) or negative (e.g., duplication). 5. Sustainability: The financial and operational sustainability of the project’s collateral registry and whether the legislative reform to the Property Law is expected to endure. 6. Replicability: The key success factors for the three pillars of the China Secured Transactions project with particular focus on the Chinese government’s acceptance of the proposed registry design and FIs’ swift adoption of the registry. 12 7. Monitoring and Evaluation—Identify potential improvements to the design and implementation of the monitoring and evaluation system of the overall approach. Figure 1.1 Evaluation framework Validation: Validate SME profile: SME business results: outcomes reported Understand what the What is the impact of beneficiaries look like access to credit on SME business performance Project outcomes… (Law development, … grow …which increase …and positively collateral registry, movables lending SME access to affects the SME awareness and capacity volume… finance… business building) FI insights: Analyze FI lending IFC additionality: Establish portfolio to establish link between the link that the project increased lending volume and SMEs contributed to increasing being able to access finance that movables lending volume they were unable to access before Methodology: This evaluation is based on the following:  Desktop research of project documents, a review of the materials produced by the project such as books, reports, and studies, a review of the media reports associated with the project efforts, as well as extensive surveys and data collected throughout the Project.  A survey of 50 FIs administered by the Research Institute of Finance and Banking, People’s Bank of China (Research Institute, PBOC). The purpose of the survey is to determine to what extent project outcomes—legal reform, registry creation, and increased awareness of movable financing—have contributed to increased movables financing by FIs, the extent increased movables financing by FIs have contributed to increased SME access to finance, and how movable lending behavior and portfolio differ among FI types. The survey sample was stratified by type of FI (Big Four, Joint-Stock, Local Banks and Other) and geography.  A survey of 126 enterprises that had access to credit using their A/R as collateral and of 121 enterprises that did not use A/R as collateral. The objective of the survey was to understand how this project has affected SME businesses on two levels: (1) the SME’s ability to access finance, and (2) the resulting impact on the SME’s business. The survey was administered by China Mainland Marketing Research Co. (CMMR), a local survey firm, via face-to-face interviews. It was conducted across cities with various degrees of SME concentration (number of registered SMEs per capita) and different geographical distribution (the coastal cities of Beijing and Hangzhou and the inland cities of Chengdu, Wuhan, and Zhengzhou).  Interviews with over 40 stakeholders in Beijing, Shanghai, Hangzhou, and Chengdu. The stakeholders include the Project’s key clients and partners in the Chinese government, such as 13 the Research Institute of Finance and Banking of PBOC, the Supreme People’s Court, and the National People’s Congress’s Legislative Affairs Commission (NPCLAC). Telephone and in-person interviews with recommended experts and consultants who had been involved with the Project were also conducted.  Case studies of FIs. The Evaluation Team conducted interviews with a range of FIs including large commercial banks (Big 5 Banks), joint-stock banks, city commercial banks, and non-bank financial institutions (NBFIs). These case studies focused on the experiences that FIs have had in adopting movable financing. Figure 1.2 Details on data sources used in the evaluation First, a few notes about each of the data sources CRC Registry FI Survey SME Survey Contents: Contents: Survey of SMEs that receive Survey of SMEs that were not • Self reported data from FIs on • Current status of movables A/R financing on the A/R registry the value of secured interest and financing enterprise type Contents: Contents: Time period: • Experience with A/R • Perspectives on access to Time period: • Conducted between 03/11- financing and impact on finance and experience • Cumulative records up to Q2 06/11 business growth obtaining finance to meet 2011 business needs Administered by: Time period: Administered by: PBOC • Conducted between 03/11- Time period: CRC 06/11 • Conducted between 03/11- Sampling: 06/11 Sampling: • Stratified based on type of FI Administered by: • 2008-2010 registrations linked according to data on most CMMR (Chinese Survey Administered by: to SME in 5 cities common sources of finance for Firm) CMMR (Chinese Survey SMEs: 5 Big 5 banks; 7 national Firm) Limitations: bank; 33 local banks; 4 foreign Sampling: • All data is self reported and not • Stratified by region: Selected • 126 enterprises, sourced Sampling: independently verified by CRC from across 4 regions from the registry with • 121 SMEs sourced from • FIs may not use consistent • Random sampling within the transaction sizes <$2M USD local business registries standards when entering data stratification, though some • 5 cities • 5 cities (E.g., definition of SME) modification based on those most likely to comply Limitations: Limitations: • High refusal rate among • High refusal rate among Limitations: potential interviewees potential interviewees • Sampling is biased towards local • Lower sampling from rural banks and cooperatives vs. their areas share of market lending activity • Non responses by FIs, often due to data not being available in the format or periodicity requested 2 The FI and SME surveys were targeted for incorporated SMEs only (legal persons). In the Chinese market, there are other types of SMEs, such as Getihu (unincorporated but registered businesses in urban areas), informal SMEs (e.g. street vendors), rural business households, etc. Many of them borrow for business purposes in personal names (they can only borrow in personal names). In FIs, such businesses are typically managed by the retail banking or consumer finance arm. This report has a few limitations, most notably in conclusively attributing observable impact indicators to the Project. The Project was not designed with a control group against which to track progress at the country16, FI, and SME levels. The sample sizes of the FI and SME surveys are 50 and 247, respectively. The small sample sizes limit the extent to which the report can generalize its findings (see 16 Note: A control group can be synthesized given a robust data set. Such a robust data set on movables lending transactions across countries is however absent. 14 Appendix C and D for a more detailed discussion of survey methodologies). Multiple government policies targeted at SMEs, including financial stimulus, during the course of the Project, are potential confounding factors. 15 2 Relevance According to its clients and government stakeholders, the Project addresses a substantial market need and supports a major national priority in China. It is also in line with the strategies of its donors and offers a complementary contribution to efforts of other donors and implementation agencies in China. This section evaluates three aspects of the Project’s relevance. First, it assesses the extent to which target project outcomes have been relevant to the needs of SMEs in China and whether it fits with the goals of IFC’s financial sector strategy. Second, it assesses the extent to which target project outcomes address issues that were of great concern to the Chinese government and its developing banking sector. Third, it assesses whether target project outcomes are consistent with the objectives of the Project’s donors and the extent to which the Project has delivered additional value compared to others in the development community. 2.1 Relevance to the intended beneficiary: SMEs Access to finance was a critical obstacle to SME development in China at the outset of the project. China’s economic structure in 2005 was similar to that of many economies IFC has worked in where SMEs lack access to finance. In a baseline survey conducted by NDRC/PEP-China, 71% of the 1,000 SMEs surveyed agreed that “lack of access to financing is the biggest constraint faced by SMEs during the course of development”. Figure 2.1 SMEs regard access to financing as their biggest constraint What is the biggest constraint faced by SMEs during the course of development? % of respondents Lack of access to financing 71% Intense competition 71% Heavy tax burden 34% No preferential policy 33% (implying lack of connections) Source: NDRC/PEP-China 2005/2006 SME Finance Survey (1,000 SMEs in Five Cities) 16 The survey, like others such as the World Bank Enterprise Surveys, also revealed that the primary obstacle to accessing finance was a lack of security acceptable to FIs. 73% of SMEs surveyed identified the absence of acceptable collateral as a key perceived reason for their lack of access to financing. This was more than double the next perceived reason—lack of information satisfactory to banks. Only 25% of SMEs agreed with that statement. Figure 2.2 Key drivers for lack of SME access to financing What is the most likely reason why you lack access to financing? % of respondents Lack security acceptable to 73% banks Lack information satisfactory 25% to banks Profit-making capacity of enterprise is not satisfactory 24% Lending agency does not 23% have resources to lend Source: NDRC/PEP-China 2005/2006 SME Finance Survey (1,000 SMEs in Five Cities) A separate survey of 25 FIs on their commercial lending portfolios and practices in China came to a similar conclusion. In 2004, only ~35% of loans were secured using collateral17. Less than 15% of all business credit in China was secured either partially or exclusively by movable assets. This reflected a low utilization of movables as security. For example, movables account for around 70% of small business financing in the United States18. Collateral is particularly important for SMEs in China to obtain access to finance because approximately half of their assets are held in inventory and receivables, compared with 30% in large firms.19 2.2 Relevance to IFC Strategy The intended impact of the Project of increasing access to finance, and specifically increasing access to finance for SMEs, are aligned with IFC’s financial sector strategy. IFC regards SMEs as a critical driver for economic and social development in emerging markets. Small businesses play a major role in creating jobs and generating income for low-income people; they foster economic growth, social 17 Source: People’s Bank of China (PBOC)-FIAS-CPDF survey of financial institutions (the “Lender Survey”), P.56. 18 Source: Reforming Secured Transactions Laws in China (June 2005), P.3, IFC. 19 Source: Ibid, P.3. 17 stability, and contribute to the development of a dynamic private sector.20 Severely constrained access to financial services for SMEs in many emerging economies hinders the ability of these economies to improve the livelihoods of the populations. In addition, IFC’s financial sector strategy is based on the belief in the power of financial inclusion. Advancing the financial inclusion agenda boosts progress toward the achievement of the Millennium Development Goals, in particular toward poverty reduction, health, education and gender equality21:  Finance reduces vulnerability to income shocks, thereby mitigating risk of falling into poverty;  Finance leads to higher income per capita, thereby facilitating achievement of many MDGs;  Finance reduces inequalities / broadens opportunities, thereby contributing to gender equality. 2.3 Relevance to China and its Financial Institutions (FIs) The Chinese government had put banking sector reform on top of its national agenda in order to fulfill its 2001 WTO accession commitment within a five-year grace period. As a result, China’s financial market was in the midst of significant reforms at the Project’s inception in 2004. China’s accession into the WTO had forced domestic banks to prepare for competition from foreign institutions by further commercializing their lending practices and receiving foreign investments. The largest banks of the domestic banking industry, starting with Bank of Communications, launched initial public offerings (IPOs) in rapid succession in 2005 and 2006. By mid-2000, competition for growth resulted in a credit market worth more than 120% of the gross domestic product (GDP). Figure 2.3 Initial public offerings of large commercial banks in China Previously State-owned Banks Date IPO Bank of Communications June 2005 USD 2 billion China Construction Bank October 2005 USD 8 billion Bank of China June 2006 USD 11 billion Industrial and Commercial Bank of China October 2006 USD 22 billion Source: news reports The 2005 World Bank Doing Business Report ranked China’s credit market laws and institutions within the bottom 20% of all countries, but ranked China among the top third of all countries on the ease of doing business, on average22. Target project outcomes address the top areas of concerns—scope of movables financing, priority and enforcement of security—highlighted by FIs as most desirable for legal and institutional reform. FIs 20 Source: “SME Banking, Opportunities in Financial Markets” IFC, 2008. 21 Source: “Toward Universal Access, Addressing the Global Challenge of Financial Inclusion” IFC, 2011. 22 Source: “Doing Business in 2005: Removing Obstacles to Growth” by World Bank Group and Oxford University Press. The ranking is based on seven sets of indicators measuring regulations of: starting a business, hiring and firing workers, registering property, getting credit, protecting investors, enforcing contracts, and closing a business. 18 operating in this environment reported that the lack of certain functioning credit institutions, such as a unified security interest registry, was a major challenge. Figure 2.4 Commercial practice beneficial to FIs in China Commercial practice that would benefit financial institutions % of Respondents that indicated “Fully Agree” to the statement Establishment of a unified, nation-wide 66 registry, which includes security interests on all types of movable assets Electronic registry that permits creditors to 63 search registry records on the internet Registration establishes priority for the 50 creditor against other lenders Registration establishes priority for the 43 creditor against the claims of tax authorities, employees, etc Registry reduces discretionary acts 39 Source: Survey on Creditor Rights Protection in China (World Bank, IFC, PBOC) Commercial practice that would benefit financial institutions % of Respondents that indicated “Fully Agree” to the statement If receivables could be transferred in bulk, rather than one account at a time 28 If future receivables could be transferred without further contractual arrangements or 16 registration upon the future creation of the accounts receivable Where receivables are transferred to a creditor, notice is required only if the creditor 14 desires the account debtor to change the place to which payment should be delivered Commercial practice that would benefit financial institutions % of Respondents that indicated “Fully Agree” to the statement If the secured creditor who has priority would have the right in all cases to take physical possession or control of the collateral 54 If the secured creditor who has priority would have the right to collect the accounts without 36 judicial process If the secured creditor who has priority would have the right in all cases to sell, lease or 32 otherwise dispose of the collateral without judicial supervision Source: Survey on Creditor Rights Protection in China (World Bank, IFC, PBOC) 19 2.4 Relevance to Donors and Additionality in Development Community The Project’s goal of increasing access to finance for SMEs by reforming the regulatory environment and developing a market for secured transactions is in line with the stated goals of its donors. Investment Climate Department of the World Bank Group (former FIAS), IFC’s Project Development Facility (CPDF), and The State Secretariat for Economic Affairs of the Government of Switzerland (SECO). The Investment Climate Department of the World Bank Group assists governments of developing countries and transition economies in reforming their business environments, with emphasis on regulatory simplification and investment generation. At the project’s inception, Chinese law governing secured transactions did not include commonly accepted principles of modern secured transaction laws.23 Collateral reform can have a far-reaching impact on overall investment climate and private sector development, which is also in line with the focus of the Investment Climate Department.24 Also, the IFC CPDF was launched to catalyze support for SME managers in the Western Region of China. The Project directly supported the growth of SMEs by promoting the reform of the financial sector and the creation of infrastructure required for the financial market, which directly aligns with CPDF’s strategy.25 The Project provided additional value to the development community by delivering unique support. Government stakeholders who worked with IFC praised three main areas that differentiated IFC support from that of other institutions in China. IFC’s support went beyond advice-giving to lending very specific and tactical assistance. For example, the NPCLAC reported that in addition to providing technical advice on legal reform, the IFC team also provided and edited detailed legal drafts for the new laws. IFC’s support was comprehensive where appropriate, and where synergies could be realized. It was not limited to activities directly involving secured transactions reform. For example, through the know-how generated by the secured transactions project, IFC also helped launch the Leasing Registry. IFC also worked with the CRC on a project involving the development of a credit bureau, and assisted by sharing information regarding default rates for A/R financing. IFC’s support was “on-demand” in its timeliness and reliability. For example, several government stakeholders praised the IFC team for giving them unlimited access to their knowledge outside of formal training sessions. This form of “on-demand” support allowed government officials to be more efficient when writing draft legislation, and also reinforced the education process provided in more formal sessions. 23 Note: Of the eight good practice principles in secured transaction laws promoted by EBRD, OAS, UNCITRAL and ADB, China’s Security Law of 1995 did not include any of these principles. 24 Source: IFC SmartLessons March 2006, by Sevi Simavi. 25 Source: Ibid. 20 Furthermore, IFC is the only entity from the development community that continues to assist the Chinese government in leading a secured transactions reform.26 Bilateral donors in China have become much less active, or have pulled out completely from traditional forms of development cooperation.27 The current donor landscape outside of IFC, and more broadly the World Bank Group, is therefore sparsely populated. It comprises Deutsche Gesellschaft fuer Internationale Zusammenarbeit (GIZ), International Fund for Agricultural Development (IFAD), United Nations Development Programme (UNDP), and Asian Development Bank (ADB). None of these organizations focus on secured transactions reform. GIZ’s financial sector reform project touches on aspects of the legal reform. 3 Effectiveness The Project was effective in delivering its intended outputs and outcomes, namely, development of a law, development of a security interest registry, and public awareness and capacity building. As a result, it broadened the scope of movable assets in the Property Law, introduced international best practices on security interest registry, and provided a knowledge platform for market participants and regulators to build consensus on the development of movables financing. Also, China’s legal rights index, rose from 0 in 2005 to 6 (on a scale of 0-10) in 2009, while its public registry coverage rose from 0% in 2005 to 83% in 2012, according to the World Bank Group’s Doing Business Report. 26 Source: Scaling-Up SME Access to Financial Services in the Developing World by SME Finance Sub-Group of the Financial Inclusion Experts Group (November 2010). 27 Source: Interview. 21 Figure 3.1 Achievements of key project indicators Select indicators Target Cumulative results % of target (updated) through last PSR achievement Select outputs Number of entities receiving in-depth advisory services: 3 5 167% Number of reports (assessments, surveys, manuals, Phase I /strategic option 10 13 130% reports) completed Number of participants in workshops, training events, seminars, conferences, 3,000 5,378 179% etc. Number of media appearance 40 350 875% Select outcomes Number of recommended laws/regulations/amendments/codes enacted: 1 3 300% Number of recommended procedures/policies practices/ standards that were 2 4 200% improved/eliminated: Number of accounts receivable security interest registrations: 50,000 384,429 769% Number of searches made on A/R security interest registrations: 100,000 489,282 489% Select impact Value of financing facilitated (USD) $200 billion $3.58 trillion 1,790% Value of SME lending against accounts receivable as collateral (USD) $200 billion $1.09 trillion 545% 3.1 Development of a Law Before the Property Law of 2007, there was a patchwork of regulations and restrictive laws governing secured transactions in China. Several laws—such as the General Principles of the Civil Law, Security Law, and the Land Administration Law—dealt separately with various aspects of property ownership and created confusing bureaucratic procedures and inefficiency. The Security Law of 1995 also put restrictions on the use of movable assets as collateral and lacked administrative guidance for FIs. An estimated USD 9 trillion in dead capital was locked within the SME sector in China.28 China’s Property Law, referred to as “China’s next revolution” by The Economist,29 was passed on March 16, 2007, and came into effect on October 1 of that year. The official legislative work started in 1993 when NPCLAC set up a working group. The drafting and passing of the law was a crucial step toward reforming secured lending and building a modern secured transactions system. 28 Source: “Secured Transactions Reform in China: Lessons and Experience” Jinchang Lai Presentation to FinNet, October 19, 2010. 29 Source: The Economist, print edition, March 10, 2007. 22 Figure 3.2 Timeline of China’s Property Law reform Preparation period Execution period Source: World Bank Doing Business Database, adopted from China’s new Property Rights Law —an important step towards improving access to credit for small and medium enterprises by Valerie Marechal, Pelin Tekin & Humay Guliyeva. Based on feedback from PBOC’s Research Institute of Finance and Banking and the Civil Law Department of the Legislative Affairs Commission of NPCLAC, the Project was effective in supporting their work in drafting and passing the relevant articles of the 2007 Property Law.30 Without the Project’s assistance, while there would likely be a chapter on secured transactions in the security law, it would likely not be up to international standards. For example, IFC had an impact on broadening the scope of movables assets defined in the 2007 Property Law. The Property Law now includes A/R and inventories in its scope. Also, IFC provided unique value during the legislative process. IFC responded to the Commission’s inquiries with analysis based on international best practices, as well as information on the national context in which these practices were adopted. The responses met the time pressure of the legislative process during which delays could undermine legislative momentum. Furthermore, the Project contributed to the drafting of other pieces of legislation required for the proper implementation of the Property Law. Contributions were made to PBOC's regulations on A/R security interest registration and leasing regulations. Based on current commercial practice, the new legal framework has addressed the FIs’ top concerns with regard to using movable assets as security.31 Most importantly, the law expanded the scope of movable collateral that can be used in a secured transaction. A single unitary security interest now applies to movable property of all kind, tangible and intangible, present and future, eliminating the positive list of assets that can be used. For example, borrowers can use present and future-acquired 30 Source: Interviews with PBOC and NPCLAC. 31 Source: Interviews with FIs. 23 equipment inventory, A/R, and a combination of assets as collateral. Furthermore, FIs can accept A/R in bulk, rather than one at a time, as security. They are not required to notify accounts debtors when accepting the receivables. FIs also have more control over defaults, as events in default are now defined by contract.32 Last but not least, the law created a more transparent priority scheme by incorporating specific rules, such as priority by date of registration and rules on proceeds. FIs suggested in our interviews that from a market adoption point of view, it was most important for the judiciary to clarify how the existing rules should be applied. Closing the gap between the existing rules and international best practices by the legislature was not as pertinent. Unlike the law from 1995, the existing regulations had already given them a framework in which to engage and experiment with movables financing. Furthermore, not all aspects of international best practice are necessarily applicable to China’s existing legal system, notably any enforcement mechanisms that bypassed the court. 3.2 Development of a Security Interest Registry The aforementioned Property Law allowed the PBOC to establish a single, centralized, online security interest registry of A/R although a unified registry system of security interest in all types of movable assets was not created. The technical assistance provided by the Project was a major contributor to the launch of the A/R Registry on October 8, 2007—a week after the Property Law became effective. The registry is located in Shanghai. CRC renamed the registry to “Registry of Security Interest in Movable Assets” in 2011 in order to position it as the registry for security interest in movables. The Project assisted the policymakers of the National People’s Congress (NPC), State Council , and PBOC with an evaluation to identify the right entity within the Chinese government to operate the newly established CRC registry. The evaluation assessed four organizations in terms of their governance/organizational structure, operational capabilities, technological capacity, and credibility in the lending community.33 CRC—formerly part of PBOC Credit Information System Bureau and currently a public service unit within PBOC—was among the top two recommended entities, and was ultimately selected to host the registry. PBOC funded the development and implementation of the registry, and issued rules that are in line with modern security interest registry principles in conjunction with the launch of the registry. CRC suggested that without consultation provided by the Project, the design of the registry might have been similar to paper-based and sub-national registries hosted in other authorities.34 The newly established registry strives to provide services that meet international criteria for best practices— secure, cost-effective, simple, accessible, speedy, and timely. It adopted best practices from Canada, United States, and New Zealand. The new registry incorporated key features of a modern registry of 32 Source: “China’s new Property Rights Law—an important step toward improving access to credit for small and medium enterprises” by Valerie Marechal, Pelin Tekin & Humay Guliyeva, World Bank. 33 Source: Evaluation of Potential Host Organizations for A/R Registry (October 2006). 34 Source: Interviews with CRC. 24 security interest in movable collateral, for example, online accessibility, user accounts, and description of assets in a central location. It simplifies the formalities required for creating security interest and improves the publicity of the system by allowing notice registration, eliminating the need to register the security agreement, and allowing any person, natural or legal, to give a security interest. PBOC’s registry consolidation proposal was not accepted during the legislation process in 2007 due to inadequate political support. The multiple registries of equipment and inventory collateral are operated by different authorities and therefore involve complex interests. The PBOC calculated that a single, unified registry could wait, considering that the passage of Chapter Four of the Property Law would be a major step forward and already required significant stakeholder buy-in. Therefore, A/Rs are registered in PBOC's new electronic registry hosted by CRC, but other security interest on movable assets, such as machinery, equipment and inventory, are registered in decentralized registries. Information on pledges of these assets is therefore not contained in a single depository and is not accessible online. FIs cannot search for existing pledges of these types of security interest in real time and have to bear additional risks when accepting these movable assets as collateral. The addition of leasing to the A/R Registry has been an important and positive development. Figure 3.3 Multiple registration systems in China Collateral type Collateral Registration agency Movable Aircraft Civil Aviation Administration Transport Vessel/Ship Maritime Safety Administration Fishing Vessel Administration of Fishery and Fishing Harbor Supervision Automobile Administration Office of the Public Security Non-Farm-Use Automobile Bureau Farm Machinery Farming Machinery Station Business Machinery and Equipment Administration for Industry and Commerce Timberland, Orchard State Forestry Administration Crops Bureau of Agriculture Miscellaneous Personal Belongings Local Notaries Rights/ Listed Securities Securities Registration and Settlement Institutions Ownership Private Securities n/a stakes Licensing Rights, Private Business Ownership Stakes Administration for Industry and Commerce Patents State Intellectual Property Office Copyrighted Works National Copyright Administration Export Tax Refund Receivables Commercial Bank Export Tax Refund Loans Administration Rights to Toll Road Revenue Streams Transportation Bureau Tuition Bureau of Education Unregulated Fee Streams Local Notaries Deposit Certificates Varies Other Rights/Ownership Stakes Varies Source: Secured Transactions Ref orm and Credit Market Development in China 2006 (Chinese publication). Having created a single registry of security interest in A/R, PBOC and the Project are working toward further consolidation of registries for other types of movable assets. The reform recognized that the new, unified registry would serve as an operating model for the different registries of security interest in other movables assets, such as equipment and inventory, to merge in the future. PBOC is now working with judiciary to produce judicial opinion on this matter. For example, a security interest registry should conduct only form review, not substantive review. While it is highly unlikely that China will have one 25 single registry of all security interest, creating a single registry of security interest in equipment and inventory managed by the Administration for Industry and Commerce remains an important objective. As soon as the CRC registry and this future AIC registry are linked and their rules harmonized, their registry service can still significantly reduce the transaction costs of secured creditors. 3.3 Public Awareness and Capacity Building The Project’s client and public sector stakeholders as well as private sector stakeholders, including FIs, NBFIs, firms, and lawyers, are target audiences of its public awareness and capacity building efforts. The Project found that in 2003 there were almost no publications and articles on the subject of movables financing in Chinese. Individuals from FIs and government authorities also lacked a working knowledge of movables financing. Participants in study trips described the positive effect of a study visit organized by the Project in October 2005.35 The study visit included a two-day workshop at the World Bank and meetings in New York, Delaware, Washington DC, and Toronto. There were nine participants including representatives from the PBOC, NPCLAC, and the National Development and Reform Commission (NDRC), a policy- coordinating body under the State Council. The Chinese officials visited movable collateral registries and held extensive discussions with bankers and lawyers on the application and the practical impact of the law. The core principles of modern secured transactions systems from North America left them with a strong impression. They also learned about the experiences of a diverse set of countries including India, Germany, Russia, Poland, as well as the United States and Canada. Stakeholder interviews show that the participants were left with a strong impression of the strength of a modern secured transactions law system in fostering access to credit. Understanding and seeing the popularity of using A/R as security during the field trips helped them develop a case for reform within the Chinese context. The PBOC-CRC also delivered eight training workshops in China on receivables financing. All training costs were covered by the PBOC and the participants. An average of 150 people participated in each workshop. The CRC also coordinated with local governments and encouraged them to issue policies or procedures to promote A/R financing. For example, Zhenjiang district of Jiangsu province issued a mandate that required enterprises to verify their accounts payables. According to commercial bankers, workshops organized by the Project served as a platform to gather market actors and build consensus, in addition to distributing conceptual and practical materials. The Project also distributed the materials developed for workshops and conferences in response to requests made by people from the banking community. The Project has sponsored three trainings for FIs and firms throughout the country, focusing on the new secured transactions system and best practices on asset-based lending techniques. The Project has organized and documented approximately 51 training events since early 2004. Several of the FIs that were interviewed stated that these forums, and the 35 Source: Interview with NPCLAC. 26 resulting publications, are one of their primary sources of information for new product or service ideas related to movables financing. Figure 3.4 Samples of project publications in Chinese and books the Project supported Source: IFC 4 Impact 4.1 Theory of Change The intended impact of the Project is to promote the development of a movables financing sector in the Chinese banking industry, which in turn, can expand access to finance for SMEs. The overall theory of change for the project has three steps: first, the combination of legal reform, market infrastructure building (security interest registry), and awareness building would create an enabling environment for FIs. FIs thus develop innovative lending products secured by movable assets to better meet the needs of businesses, particularly SMEs. Second, this instrument of movables financing would enable the banking sector to better serve the SME market and thus increase access to finance for SMEs. Third, that increased access to finance would positively affect the business performance of SMEs. 27 Figure 4.1 Three levels of the Project impact IFC Project Impact: SME profile insight: SME business insight: Understand what the What is the impact of beneficiaries look like access to credit on SME business performance 1 2 3 …and positively … develop the …which increases IFC project affects SME movables SME access to outcomes… business financing sector… finance… performance FI insight: Analyze FI lending portfolio to establish link that the increased lending volume truly resulted in SMEs being able to access finance, that they were not able to access before This theory of change was based on previous experiences with secured transactions reform in other countries. The project in China offers an interesting opportunity to explore the extent to which key assumptions within this theory of change hold true in the Chinese context, such as:  If the enabling environment for movables financing (e.g., changes in regulations, new market infrastructure) is improved, FIs will respond by introducing new products and expanding lending volumes  If FIs offer movables financing (increase the supply), there will be sufficient demand from SMEs to access these new types of lending products  SMEs that are able to access financing from FIs that offer movables lending would not otherwise have been able to access finance through fixed asset lending alone  Credit afforded to businesses through movables financing has a positive impact on the SME’s business performance This section will examine each aspect of the theory of change, as well as the key assumptions underpinning it. Specifically, section 7.2 captures the overall trends in the rate of adoption and use of movables financing in China and the lending practices that FIs employ. Section 7.3 discusses the changes in FIs’ lending patterns to SMEs, and to what extent movables financing has contributed to these changes. It also identifies the profile of SMEs that have been able to receive credits secured by movable assets. Finally, section 7.4 provides a summary of the observable impact at the SME level. 28 4.2 Emerging Movables Financing Sector 4.2.1 Introduction As described in section 3, IFC’s assistance enabled PBOC to improve the market infrastructure upon which FIs can develop products and services to serve their clients, large or small . This examination of the movables financing sector will consider IFC’s efforts at two levels. First we will examine the movables financing sector as a whole (all relevant asset types) because IFC’s efforts to strengthen the overall regulatory framework for movables financing should produce some positive changes across the entire industry. We will then examine the A/R sector in greater depth, because this was a key feature of IFC’s intervention. For both of these levels, particular emphasis will be placed on extending these practices to SMEs. 4.2.2 Trends in the overall movables financing sector as a whole Movables financing is now growing strongly in China. 90% of the 50 FIs surveyed for this evaluation engage in movables financing for their clients. This number includes FI’s that use movables financing for large, medium, and small enterprises. FIs reported strong growth in the value and number of their loans secured by movable collateral since 2006. However, there is a distinct increase in the rate of growth of movables financing after 2008. This is notable because the interventions supported by IFC (regulatory changes) took place in late 2007. 2008 was a year in which many of the FIs responded to these changes by developing and operationalizing new lending practices. As a result, the rate of increase in movables financing in the period 2008-2010 is notable. The total number of commercial loans involving movable assets grew by 21% per year in 2008-2010 vs. a flat rate in 2006-2008. These commercial loans include loans secured exclusively by movables as well as those secured by a combination of movables and immovables. Their value also grew from an annual rate of 15% in 2006-2008 to 24% in 2008-2010. 29 Figure 4.2 Growth of commercial loan portfolio secured by exclusively movable assets Total number of outstanding loans involving movables Total amount of outstanding loans involving movables at the end of the year at the end of the year +21% +24% CAGR 0% CAGR +15% 2006 2008 2010 2006 2008 2010 Source: 50 FIs surveyed in six provinces of China (Anhui, Guangdong, Shaanxi, Shandong, Shanghai, and Zhejiang) Loans secured by movable collateral are still a relatively small share of overall secured lending when compared to developed markets, but all trends point to strong upward trajectory. 2008-2010 was a period of significant financial sector expansion in China as indicated by the strong growth of overall loan volumes. During this period, both the value and number of loans secured by movable collaterals grew faster than those secured by other forms of assets. The number of commercial loans involving movables occupies a significantly smaller share of overall secured portfolios36. As a segment, it has to grow faster just to keep its share. This segment of local banks got a boost between 2006 and 2008. The Big 5 banks then picked up the growth in 2008. The segments of local banks and Big 5 banks represented about three quarters of the size of the Chinese banking sector in 2010 in terms of their share of total assets and liabilities. 36 Secured portfolio is comprised by three types of loans: those secured exclusively by immovables (real estate), those secured exclusively by movables, and those secured by both (i.e., those involving movable assets) 30 Figure 4.3 Commercial loan portfolio secured by movable assets vs. other forms of assets Average share of commercial loan involving movables as % Share of total assets and liabilities of of total secured portfolio, in terms of number of loans the Chinese banking sector in 2010 Local banks Big 5 banks Big 5 banks +25% >3,000 local banks 15 policy and large commercial banks +30% 33% 40 foreign banks 24% 27% 27% 22% 2% 18% 24% 49% 25% 2006 2008 2010 2006 2008 2010 N: 29 32 33 3 3 3 Source: 50 FIs surveyed in six provinces of China (Anhui, Guangdong, Shaanxi, Shandong, Shanghai, Zhejiang) The movables financing sector is not only increasing in size, but also expanding its product offerings. Early product development took place before the passage of the 2007 Property Law and happened at both the headquarters and regional level. HSBC adapted Hong Kong headquarters practices for the China market before 2007. On the other hand, ICBC had started pilot programs both through their headquarters and through select local branches where particular needs were identified. An ICBC interviewee said that “the most important source of information is the clients themselves.” Once the provincial-level branch management had developed a new product, they reported it back to headquarters for syndication in other regions. Later adopters of movables financing noted that their key sources of ideas for product development included the demonstration effects of market leaders and smaller, more specialized FIs. Some FIs interviewed also pointed to a convening organized by PBOC and IFC as a useful source of information about new product innovations. Financial News, a leading Chinese newspaper in financial news reporting, independently reported 36 cases of such product innovations and later published them in a book in September of 2010. PBOC also collected more than 200 cases of product innovations and published 120 of them in a book with significant inputs from the IFC Project. 31 Figure 4.4 Product innovations in movables financing Type Financial Collateral Detailed description Institution involved Inventory Industrial Bank Warehouse Pledging of standard warehouse receipts from Shanghai Futures Exchange to obtain short- receipts term financing primarily for liquidity purposes. The bank monitors market value of the receipts to ensure a minimum coverage ratio on the credit limit. Inventory Bank of Wheat (raw The company needs large financing to acquire wheat stock from June to September. Wheat Communications ingredient) is used as a collateral, and the bank also works with the warehousing company to sign the monitoring/pledging agreement. Inventory Baoji City Feng Mineral The company was able to secure a loan based on existing inventory after the prices _ had County Credit fallen drastically due to the financial crisis. The financing obtained gave short-term liquidity Cooperative necessary to sustain the business over a low tide. Supply chain China Merchants Supply chain “1+N” supply chain financing consists of a core enterprise of good standing and smaller financing Bank collaboration enterprises occupying different parts of the chain. Credit limit to the smaller enterprises is based on the financial information derived from the supply chain collaboration provided by the core enterprise. Supply chain CITIC Bank Steel and iron Operates on the idea of the steel/iron factory as the core enterprise; provides financial financing financial products to facilitate the transactions within the supply chain, including commercial bills network and loans. The bank utilizes purchase orders as collateral for short-term liquidity financing. Supply chain Bank of Inventory Bank supplies financing to coal wholesale distributor with coal inventory pledged as financing Communications logistics collateral; inventory is held under custody of third-party logistics and depository company, which helps to monitor the value/quantity of inventory, and provides support for transport on behalf of the enterprise. Floating China Minsheng Gold jewelry Third-party company monitors daily prices of gold and the quantity of collateral from gold charge Banking Corp. floating charge jewelry firms for the bank. Credit limit is adjusted when gold price falls below 5% of set price; the business needs to “top up” when the market value of the collateral falls below 110% of the pledged value. Floating Jingshan County Livestock Turtles (and other livestock) pledged as collateral, using lowest market value. Duration of charge Rural Credit (turtles) the loan is determined based on life/breeding cycle of the livestock. Focuses on stable Cooperative floating charge markets with mature technical competency, low risks of diseases. Equipment Qiqi Harbin Agricultural Mortgages for agriculture equipment, for farmers that wish to purchase equipment but do and Longjiang County equipment not have financing. Actual loan amount depends on value of the equipment and other machinery available guarantees. Intellectual Shanghai Pudong Intellectual Bank employed third-party valuation experts to assess the value of a software company’s property, Development Bank property and intellectual property and trademarks. The bank also works with government exchange trademarks trademarks platform to legally pledge the IP/trademark right to the bank. Risk is shared among third- party assessment agency, the bank, and government guarantee co. Intellectual Chengdu Huifu Bean-product Mutual guarantee/trademark provided as counter-collateral. Bean-product businesses property, Guarantee Co. trademark belonging to a registered association enjoy the right to use this trademark, which can be trademarks used as a counter-collateral. Equity stake Suizhou Zengdu Equity stake Pledging of equity stake in a subsidiary co. Scope is still limited as objective valuation as Hufeng Village Bank well as monitoring difficult in an unlisted company; realization of value also difficult for an unlisted stock. Other special Construction Bank Artwork Traditional Chinese artwork owned by a cultural organization pledged as collateral. Valued innovations of China by a team of five experts with on-site due diligence and market research, further employed third-party management to monitor and facilitate any logistics on exhibitions. Other special Huaxia Bank Mutual support Guarantee/risk fund draws contributions from each member enterprise; each member is innovations fund (mutual responsible not only for its own loan repayments but also the potential defaults of other guarantee) members. This allows companies that trust each other and understand each other’s business to enter into group lending. Other special Ducang County Livestock and Breeding pig livestock and its associated insurance pledged as collateral; in case of any innovations Rural Cooperative livestock losses, compensation will go directly to the bank. Expands scope of possible rural financing insurance channels. Other special Ducang County Livestock and Breeding pig livestock and its associated insurance pledged as collateral; in case of any innovations Rural Cooperative livestock losses, compensation will go directly to the bank. insurance Source: Successful Models on Movable Collateral Innovation in China (2010), published by PBOC and IFC 32 Core components of the IFC Project—namely the 2007 Property Law and the A/R Registry—were among key drivers of the adoption of lending secured by movable collateral. A survey of 50 FIs revealed that these drivers are the top two reasons for the FIs’ increasing portfolio of loans secured by movable collateral, besides their business imperative to improve their service for the SME market. Figure 4.5 Reasons for the increased lending secured by movable collateral among surveyed FIs FIs looking f or better 55% 40% 4% ways to serve SMEs 0% Passage of 2007 34% 43% 23% 0% Property Law Establishment of 30% 37% 30% 2% new A/R registry Increasing degree of competition f rom 13% 52% 30% 4% other FI s Enables FI s to obtain more inf ormation 21% 36% 36% 6% and reduce risk Risk diversif ication 26% 30% 43% 2% Increased access to inf ormation about 6% 36% 49% 9% movables lending n = 47 Very Important Important Slightly Important Not Important 100% Source: 50 FIs surveyed in six provinces of China (Anhui, Guangdong, Shaanxi, Shandong, Shanghai, and Zhejiang) The key area for future development in the industry is systems for enforcement of claims. Overall default rates for loans secured by movable finance remain low. The mean default rate for A/R lending is 0.45 and the mean default rate for inventory is 0.6. However, in both qualitative interviews and quantitative survey questions, FIs expressed a desire for clearer, more transparent enforcement provisions, as well as a more efficient means to resolve claims. According to the FI survey, the mean time for enforcing a claim ranged from 3 months for negotiating with clients, 9 months in court, and 12 months for arbitration. The development of movables financing has also had spillover effects into other types of financing, notably leasing and factoring. The value of factoring grew from 2.6 billion Euros in 2003 to 67.3 billion Euros in 2009, according to data from Factors Chain International. The Project has also made an important contribution to the leasing industry both directly and indirectly. Prior to 2009, there was no registry for financial leases in China however there was considerable demand for one from the leasing 33 industry37. In 2009, CRC introduced a Lease Interest Registry modeled after the A/R Registry. As of June 30, 2011, the registry has 35,426 filings, enabling further growth of the leasing industry by providing lenders with greater transparency. The Project also provided indirect benefits to leasing companies in that the A/R Registry can be used by Leasing Companies themselves to pledge the A/R from their leases in order to secure additional capital. The evaluation team met with a leasing firm on the China mission that highlighted the important role that the Project played in facilitating growth in the leasing industry in China. 4.2.3 Insights on the adoption and practice of A/R financing There has been a remarkable growth in the use of A/R as collateral since 2006. By the end of June 2011, CRC has recorded cumulative value of A/R financing of USD 3.5 trillion in the A/R Registry since October 2007. In total, ~385,000 transactions involving A/R and factoring from the start of 2007Q4 to the end of 2011Q2 have been registered with the CRC. Notably, the number of transactions has increased each year, suggesting growing momentum in the adoption of this form of financing. While the absolute number of registrations is likely somewhat overstated because of data input issues according to CRC, it still shows a clear sense of the remarkable growth during the past few years. The CRC statistics also revealed a greater number of record searches than of registrations. It is an indicator that FIs are taking advantage of the registry by looking into existing encumbrances before granting loans secured by A/R. 37 Source: “A/R Registry and Movables Financing in China: Experience and Challenges” Presentation by Wang Lu Wang Lu, Deputy Director General Credit Reference Center (CRC), People’ s Bank of China (PBoC), March 2011, Brazil. 34 Figure 4.6 Growth in the number of registrations of A/R transactions Tot al Number of Registrations (A/R and factoring) in the Cumulative Number of Registrations and Movables Financing Registry Searches (2007Q4-2011Q2) 384,429 500,000 Searches 96,444 450,000 Registrations 400,000 350,000 300,000 159,718 250,000 200,000 150,000 85,020 100,000 50,000 9,445 33,802 0 2007 Q4 2008 2009 2010 2011 Total 2007 2008 2009 2010 2011 2012 Q1-Q2 Source: CRC Furthermore, the rapid adoption of A/R lending is evidenced by the number of FIs that are using the CRC A/R Registry. The CRC reports that 100% of the 20 nationwide banks in China, including the Big 5, are now registered active users of the A/R Registry. Among the surveyed FIs that accept A/R as collateral, 79% had launched institution-wide policies by 2008-2010. The majority of A/R financing occurs in eastern China, primarily in the coastal regions, in line with where most SMEs and economic activities occur. Beijing and Shanghai, which have the highest number of SMEs per capita, as well as Guangdong, Jiangsu, Zhejiang, and Shandong, which have a large number of SMEs, are six coastal geographies with the largest number of A/R financing registrations. Fujian and, to a lesser extent, Hubei and Chongqing, represent geographies with relatively high numbers of registrations given their SME populations. All large nationwide banks in China have adopted A/R financing while smaller, local, banks appear to lag in adoption. According to CRC, the Industrial and Commercial Bank of China (ICBC), one of the largest banks in China and the world, is the largest provider of A/R financing, responsible for 44% of all registrations in the registry. In addition to ICBC, large banks tend to be the leaders in terms of the volume of A/R financing. The Big 5 banks account for 24% of registrations, while 15 nationwide banks account for 16% of the registrations. This is very much in line with the banks’ relative market share and loan lending volumes overall. Qualitative interviews suggest that larger banks have been able to adopt and deploy A/R financing faster than smaller regional banks. The reason for the faster adoption rates among larger banks is their advanced capabilities for product development and their broad network through which products can be readily deployed. In our interviews with larger banks, we found that they had sufficient scale to be able to develop specialized experts dedicated to A/R financing. In some cases, the large FIs stated that they 35 had developed products that were similar in nature—such as factoring or trade finance—and so the idea of using intangible assets to secure financial transactions was not entirely new. The larger banks also cited their broad network of branches as a critical asset. Regional branches were often a source of innovation. For example, branches that had large concentrations of clients in key sectors such as manufacturing and wholesale trading were able to translate that industry expertise into developing loan products that utilized movable assets. These innovations were then shared with headquarters, which were then able to support a broader rollout throughout the full network. While local banks are an important source of finance for SMEs, they are among the later adopters of A/R financing. Local domestic banks represent only 7% of the total share of registrations in the CRC database. Our survey of 50 FIs shows a similar market landscape. 14 of the surveyed FIs stated that they do not yet accept A/R. All of these FIs are local banks: 4 rural credit cooperatives, 6 rural cooperative banks, 1 rural commercial bank, and 3 city commercial banks. It is worth noting, however, that these 14 FIs are actively considering the acceptance of A/R as collateral according to the Research Institute of Finance and Banking. While these smaller, more specialized FIs (e.g., agricultural banks in rural regions) are “closer to their clients,” their capacity for new product development and adopting new forms of lending is more varied. Figure 4.7 Indicators of market adoption of A/R financing in China Cumulative share of number of registrations by Financial Geographical Distribution of A/R Financing Registration Institution in China (2007Q4-2011Q2) (2007Q4-2011Q2) Others Heilongjiang Foreign banks 6% Jilin Local domestic banks 3% Xinjiang Liaoning 7% Inner Beijing Gansu Mongolia Hebei Tianjin Shanxi 44% ICBC Ningxia Qinghai Shandong 16% Jiangsu Shaanxi Henan Shangh Anhui Tibet ai ChongqiHubei Zhejiang Sichuan ng Jiangxi Rest of national banks Hunan Fujian Guizhou 24% Yunnan Guangxi Guangdon g Taiwan Rest of Big 5 Hainan Total = 384,429 >50,000 10-50,000 5-10,000 <5,000 Source: Credit Reference Center (CRC) According to the FI Survey, the most commonly cited reason for not adopting A/R financing is the perception that there is greater risk involved. Qualitative interviews confirmed this perspective. The key sources of perceived risk include (1) challenges in verifying the value or quality of the asset, (2) challenges in monitoring the value of the receivable, (3) concerns about the ability to enforce a claim on the receivable, and (4) concerns about the ability to recover the full value of the asset in the event of default, especially if the debtor is also an SME or in the same sector as the borrower. In an interesting contrast, interviews revealed that large nationwide banks view A/R lending as a potential way to actually reduce risk. Banks indicated that their ability to have much better visibility into the financial position of their SME clients was one of the key benefits for introducing movables financing. A/R financing enable 36 them to access recent data on cash flows and balance sheets that offer better insights into how to manage lending risks than those secured by real estate. Other banks we interviewed also indicated that their major criterion for lending based on A/R is the financial viability of the borrower as a whole, not just collateral. This contrast in views among smaller versus larger FIs points to an opportunity for raising greater awareness among smaller FIs of the potential benefits of offering A/R financing. The introduction of movables financing in some cases triggered an overall improvement in the FI’s risk management practices. For example, at the FI level, the increased awareness and focus on secured transactions lending was cited by at least one of our interviewees as contributing to an overall strengthening of risk management practices. The representative of the FI described that the introduction of movables financing sparked an overall review of risk management practices. For example, the FI’s risk management processes now involve reviewing the actual financial position of a borrower and adjusting the financing level. The representative from the FI also described how this increased scrutiny on A/Rs triggered many of their clients to adopt much stronger internal practices for managing their cash flow, which in turn has contributed to an overall lower loss from default rate at the FI level. Importantly, the default rate of A/R financing is lower than immovables financing and loans backed by guarantees, except in two cases where the default rates are estimated as equal. 20 FIs provided estimates in the FI Survey. Figure 4.8 Reasons for not utilizing A/R as security interest Lenders: Reasons for non-acceptance of A/R as collateral Borrowers: Perception of why lenders do not accept A/R Lending on the basis of A/R involves 13 greater risk Part of the debtor’s A/R can 95 Dif f icult or costly to not be verif ied monitor the value 11 of the A/R Debtor is not 48 Hard to a large enterprise enf orce in case 10 of def ault Debtor is a Not in line with FI’s 29 f oreign entity current strategic 4 priorities Other 15 The legal provisions 3 are inadequate n = 14 n = 126 Note: Respondents can choose more than one answer Source: 50 FIs surveyed in six provinces of China and 126 enterprises surveyed in Beijing, Chengdu, Hangzhou, Wuhan, and Zhengzhou, respectively FIs favor debtors that are either large firms or governments over ‘ordinary’ enterprises. FIs reported higher frequency with which they accept receivables from large firms. In terms of financing method, survey data show that FIs are financing on the basis of both specific and multiple A/R. Specifically, 60- 65% of the surveyed FIs frequently and occasionally finance on both bases. Our interviews with FIs 37 suggest that they initially start lending on the basis of a specific receivable and eventually develop the verification and monitoring systems to move to a system of lending in bulk. The costs of monitoring and enforcement in case of default are also among FIs’ top concerns. As most FIs are relatively new adopters of movables financing, they are still exploring different ways of monitoring movable collateral. Interviews with FIs in China revealed that the larger and more experienced FIs had electronic monitoring systems that allowed real time access to client financial records. FIs that had adopted these systems recognized that A/R financing can actually lower the risk of loan default through improving transparency in the SME client’s actual business performance. Almost all FIs that were interviewed expressed interest in learning more about how to improve their monitoring techniques, indicating a good opportunity for further market development interventions by regulatory authorities Figure 4.9 Reasons for non-acceptance of A/R as collateral—perspectives from lenders and borrowers Types of typically acceptable A/R debtors for SME borrowers Frequency with which the FI accept following types of debtors for SME borrowers Debtor type Large, domestic 74 enterprises Financing on the basis of 43% 29% 20% 9% receivables f rom large f irms Government 64 Lender’s 39 existing clients Financing on the basis of 17% 20% 40% 23% receivables f rom SMEs Ordinary clients with 14 qualif ied A/R Frequently Occasionally Inf requently Never Other 8 Note: Respondents can choose more than one answer Source: 126 enterprises surveyed in Beijing, Chengdu, Hangzhou, Wuhan, and Zhengzhou and 50 FIs surveyed in six provinces of China, respectively 4.3 SME Access to Finance 4.3.1 Insights on breaking a barrier for SME financing The SME lending market has grown strongly in the 2008-2010 period. FIs, particularly large nationwide banks, expanded both the number of SME clients and lending volume at a greater rate compared to the period of 2006-2008, based on our FI Survey results. Local banks also experienced strong absolute growth in SME lending, although they have more consistent growth rates across client types. All of the FIs interviewed stated that their business strategy involved pursuing SMEs as a growth segment. Some stated that other banking segments have started to slow down. SMEs were perceived as an increasingly 38 attractive source of growth and diversification for the larger banks in particular. Some FIs pointed to the increasing level of competition among FIs in China as driving the need for FIs to increasingly innovate their products and services, as a way to remain competitive in the rapidly evolving financial sector. Among the many potential drivers of SME lending, the increased demand and opportunities in the market was by far the most often cited reason for an FI’s increase in SME lending. Figure 4.10 SME lending growth and its drivers % change in the # of borrowers before and after 2007 % change in the value of lending before and after 2007 2006 - 2008 CAGR 25% # of instances in which the FIs rated a factor as the 2008 - 2010 CAGR most important reason for growth in SME lending Big 5 Banks 11% 12% Increased demands and 11% 35 opportunities from SMEs 2% Increasing competition 7 2% from other FIs -1% -1% Increased incentives 4 n=4 SME Clients Non-SME Clients SME Clients Non-SME Clients to serve SMEs 45% <> Passage of 2007 property law 3 44% Other National Banks 2009 financial 1 stimulus by China 26% Establishment of a 0 20% central registry for A/R 17% 18% 9% 7% n = 50 n=7 SME Clients Non-SME Clients SME Clients Non-SME Clients Source: 50 FIs surveyed in six provinces of China (Anhui, Guangdong, Shaanxi, Shandong, Shanghai, Zhejiang) The strong growth of lending is in line with the expanding economy and credit in China but a strong growth in lending to SMEs is not guaranteed. A review of the annual reports of all large nationwide banks shows that many started to regard the SME segment as a potentially important market only in 2007 or later. And only a few of them, such as China Merchants Bank and Shenzhen Development Bank, highlighted specifics on their product offerings or elaborated SME banking as one of their key strategic focuses. 39 Figure 4.11 Timing of increased focus on SME market by nationwide banks 2005 2006 2007 2008 2009 2010 Agricultural Bank of C hina* Bank of C hina Bank of C ommunications* C hina C ITIC Bank C hina C onstruction Bank C hina Merchants Bank Legend No publicly available information Guandong Dev Bank No mentioning of SME banking Huaxia* SME banking as a segment IC BC Emphasis on SME banking Industrial Pilot actions on SME banking Shanghai Pudong Deepened products and results Shenzhen Dev Bank Elaboratd SME banking as key strategy Source: Annual reports. * Indicates that a bank’s 2010 annual report is not accessible; the bank’s 2010 SME strategy is assumed to be the same as that in 2009. Source: All 2010 and strategic information from prospectus of H-share rights issue published 29 November 2010; 2007 and 2003 financials from 2008 and 2004 company annual reports. The Project’s second level of impact occurs when the instrument of movables financing reduces a key barrier—lack of acceptable collateral—for SMEs to obtain credits from FIs. Results from a 2005 joint People’s Bank of China (PBOC)-FIAS-CPDF survey of FIs show that loans secured by movables in China require higher ratios of collateral to debt: 170% compared with 145% for urban property. Small firms are affected the most. Approximately half of SME assets are held in inventory and receivables, compared with 30% in large firms. Collateral also is more important in general for small firms to obtain access to credit: only 5% of small firm loans are unsecured compared with 27% of large firms. Our survey of 50 FIs in 2011 also reveals that an increase in SMEs’ access to finance is seen as the most important impact of the 2007 Property Law, followed by the serving of SMEs not previously serviced, in line with the assumption made in the IFC Project’s theory of change. 40 Figure 4.12 Perceived impact of IFC Project outcomes Overall impact of 2007 Property Law on FI lending behavior 100% Increase access to f inance f or enterprises of all sizes 52% 44% 4% To serve SMEs and previously not serviced market segments 44% 42% 13% For the SMB customers meet their business needs better 40% 52% 8% The existing SME customers a new loan products 36% 60% 4% 0% Real estate f inancing by reducing cost of loans 23% 45% 28% 4% to SMEs To attract, develop new SME customers 23% 69% 8% 0% More inf ormation on SME customers 18% 57% 18% 6% Very Important Somewhat Important Not Very Important Not At All Source: 50 FIs surveyed in Anhui, Guangdong, Shanxi, Shandong, Shanghai, Zhejiang,Beijing Movables financing serves SMEs that consider a lack of acceptable collateral to be their most critical barrier to obtaining credits. When SMEs that recently obtained A/R financing were asked what factors may have contributed to unsuccessful loan applications in the past, they regard the lack of acceptable collateral as by far the most important factor. In contrast, for a comparable group of SMEs that did not recently borrow using A/R, the lack of acceptable collateral is not the most often cited reason for unsuccessful loan applications in the past. The high cost of borrowing was the most frequently cited reason instead. Movables financing is particularly applicable to SMEs that previously could not obtain credits because of their lack of immovable assets. (See Appendix D for more detailed discussion in the comparability between the two groups of SMEs) 41 Figure 4.13 Perceived reasons for unsuccessful loan applications Top reasons of SMEs with A/R loans for Top reasons of SMEs without A/R loans for denying their loan applications denying their loan applications 21 10 8 8 11 5 9 4 6 5 UnacceptableDistrust High costs Lender Unacceptable Unacceptable Distrust High costs Lender Unacceptable collateral private has covenant collateral private has covenant enterprise inadequate enterprise inadequate n = 37 capital n = 21 capital Note: Respondents can choose more than one answer Source: 50 FIs surveyed in six provinces of China (Anhui, Guangdong, Shaanxi, Shandong, Shanghai, and Zhejiang) Furthermore, movables financing is fulfilling an important part of the financing needs for the SME segment. Without their current access to movables financing, close to 60% of the surveyed SMEs believe that their business development would be severely impacted, and in some cases, the business’ very survival would be threatened. It is worth noting that these SMEs did not necessarily rely exclusively on A/R as collateral. 65% of them secured their borrowing through a combination of A/R and other assets. Overall, FIs likely enabled previously unqualified SMEs to obtain credit by accepting at least a portion of the collateral for the loan in the form of A/R. Figure 4.14 Perceived impact if A/R loans were taken away 2% 2 13% 57 1 1 SMEs with A/R as sole collateral 20 SMEs with other credit arrangements 28% 37 57% 28 12 13 16 8 Minimal impact 5 Impact development to some extent Minimal impact Impact Impact Threaten Impact development severely development development SMEs survival Threaten SMEs survival n = 100 to some extent severely Source: Enterprises surveyed in Beijing, Chengdu, Hangzhou, Wuhan, and Zhengzhou However, there is evidence that further awareness raising is needed. In the survey among SMEs that had not received a loan based on A/R financing, 84% of SMEs that have not recently used A/R as collaterals 42 did not mention A/R as a potential source of assets for collateral purposes38. These SMEs were already located in main cities of their respective provinces. Overall, this result points to greater opportunities to make SMEs aware of the possibility and benefits of movable financing. 4.3.2 Insights on SME financing trends Movables financing for SMEs, especially lending secured by A/R and inventories, has grown quickly since 2006. While it remains a relatively small share of financing for SMEs, the majority of surveyed FIs accept movable collateral from SMEs. During our interview, all FIs stated that the 2007 legal and registry reform and subsequent industry development that resulted from the IFC Project have enabled them to extend more finance to SME clients. However, most FIs were unable to accurately disaggregate the extent to which movables financing was enabling them to reach new SME clients, or if it was being used to extend increasing finance to existing clients. In the case of increasing finance to existing SME clients, FIs stated that movables financing has enabled them to offer their clients more appropriate forms of finance and to better manage the risk of their lending to SMEs through improved transparency into the client’s financial position. One FI said that they were using A/R financing as a way to offer clients a lower cost option to financing, rather than working through guarantee companies (which usually impose a 2% guarantee fee in addition to interest rates). Overall Movables Financing Majority of FIs accept Movable Collateral from SMEs; though a relatively small share of Figure 4.15 Lending financing to SMEs for SMEs, by form movable of acceptable financing collateral is fast growing Lending to SME clients Movable Collateral Land Use Rights Guarantees Accounts For Buildings Inventory # of adoption among 50 Receivable surveyed FIs Accepts this form of collateral 36 29 47 45 Does not N/A +20% RMB 30 Trillion +14% 25 20 Value of SME Loans Outstanding among the 15 50 surveyed FIs, by type of security that is used as 10 collateral 5 +87% +53% 2006 2011 0 Guarantee Land use rights A/R Inventory CAGR Approx. amount of outstanding loans from SME clients Note: The value of lending by surveyed FIs is likely underreported because of data compliance issues among some of the larger FIs • Note: The volume of lending by surveyed FIs is likely under reported because of data compliance issues among some of the larger FIs Source: 50 FIs surveyed • in six provinces Source: (Anhui, of Chinain 50 FIs surveyed Anhui,Guangdong, Guangdong,Shaanxi, Shanxi, Shandong, Shandong, Shanghai, Shanghai,and Zhejiang) Zhejiang 33 In terms of serving new SMEs, FIs reported in interviews that they were using A/R and inventory financing to reach potential new clients in the manufacturing, wholesale and retail, and 38 Respondents were asked an open ended question to list their understanding of acceptable forms of collateral. 43 transportation, and storage sectors. One FI estimated that approximately 60% of the secured transactions volume is with existing clients, while 40% is with new clients. This FI said these new clients tended to be SMEs unable to access some kind of financing before, but looking to lower their cost of borrowing, or SMEs that have fully mortgaged any of their existing real property, but are still in need of short-term finance for working capital. However, FIs were not able to quantify with precision the magnitude of these trends. Figure 4.16 Sectors most relevant to FI movable lending Relevance of movable lending to Fis by industry sectors 100% Wholesale and retail trade 27% 27% 31% 15% Manufacturing 22% 37% 33% 8% Transportation and storage 16% 24% 33% 27% Information and communication 5% 20% 33% 43% Construction 5% 5% 52% 38% Rental and leasing activities 3% 10% 36% 51% Mining and quarrying 2% 10% 37% 51% Agriculture,forestry and fishing 2% 9% 39% 50% Professional,scientific and 26% 67% 5% technical activities 3% n = 50 Highly Relevant Relevant Somewhat Relevant Not Relevant Source: 50 FIs surveyed in six provinces of China (Anhui, Guangdong, Shaanxi, Shandong, Shanghai, and Zhejiang) The key challenges that FIs described when lending to SMEs is information asymmetry, lack of collateral, and the financial constraints faced by SMEs when managing growth (e.g., fast-growing SMEs can face cash flow and working capital pressure). There are also concerns among FIs about how the SMEs use the loans they receive. For example SMEs may choose to use the funds toward existing operations rather than new investments. In response to these challenges, FIs have developed new product offerings that better meet the needs of SMEs and take movable collateral as security interest. 44 Figure 4.17 Sample product innovations of A/R financing Financial Region Collateral Detailed description Institution involved Dunhua City Jilin Government Farmers are able to use future subsidies from government as Rural Credit subsidy to collateral for loans of five years or less. In this manner, they Cooperative farmers are able to purchase materials for spring sowing season and resolve any other cash flow issues. Jieshou City Anhui Value-add Businesses in the recycling industry are able to receive 70% tax Rural Credit tax rebates rebates based on a national policy established in 2008. This Cooperative from frees up the cash flow occupied by taxes to use for working recycling capital. Loans typically take only 10 days to approve. Agricultural Fujian Tourist sites The Management Committee (government appointed) of the Bank of China fee Guanmaoshan tourist area collects fees (entrance fees, boat (Liancheng collection transport fees) and pledges their fee collection right for loans, County Branch) right based on a credit limit not exceeding 32.5% of the net asset value as determined by third-party valuation. China Yunnan Hospital fee A hospital in Chuxiongzhou pledged fee-collection right of the Construction collection period 2010 to 2015. Credit limit is determined as a portion of Bank right the net present value of future net income Source: Successful Models on Movable Collateral Innovation in China (2010), published by PBOC and IFC. 4.3.3 The number and profile of SMEs that receive A/R financing The CRC Registry has recorded ~385,000 transactions from the start of October 2007 until the end of June 2011. The priority of claims over a particular A/R is determined by the timing of the record in the registry. Therefore, FIs are motivated to record each of their lending transactions involving A/R. Nonetheless, the CRC found mistakes in data inputs due to misunderstandings on the part of the FIs (See Appendix C for more detailed discussion on potential data errors). For example, there were some instances where FIs registered multiple entries of the same transaction. It has recently introduced a nominal fee of RMB 100 in part to encourage FIs to input data more carefully. Further analysis of CRC database indicates that there is a high incidence of repeat borrowers, as a result the number of transactions cannot be equated with the number of borrowers. These figures also do not include transactions involving leasing. As of June 30, 2011, there were 35,426 registrations in the leasing registry. 45 Figure 4.18 Number of registered A/R registrations and searches Number of registrations in the Accounts Receivable Registry Registered loans involving accounts receivables (2007Q4-2011Q2) 384,429 96,444 City % of total Sample size One-time Repeat borrower borrower 159,718 Beijing 58% 42% 857 Chengdu 66% 34% 999 Hangzhou 55% 45% 995 85,020 33,802 Wuhan 64% 36% 957 9,445 Zhengzhou 87% 13% 322 2007 Q4 2008 2009 2010 2011 Total Total 63% 37% 4,130 Q1-Q2 Source: Credit Reference Center (CRC) CRC reports that 68,575 SMEs have received financing secured by A/R totaling USD 1.09 trillion. This number is less than what was previously reported IFC Project Supervision Documents due to the prevalence of repeat borrowing. Throughout the project, the number of transactions was used as a means to indicate the number of times firms were able to access finance. Through further refinement of the registry database, the CRC was recently able to produce figures on the number of unique borrowers in the database. CRC reports that there are 68,575 unique SME borrowers that have been registered since October 2007. The caveat to these numbers is that the designation of these borrowers as SME is self-reported by FIs and not verified by CRC. However, it is likely the most reliable estimate of the number of SMEs that obtain financing secured by movable assets. It should also be noted that the figures on SMEs provided by CRC include only “incorporated SMEs,” and do not include unincorporated enterprises such as smallholder farmers, business individuals, or public service units. Public service units do not typically need to borrow, though some, such as hospitals and educational institutions, do. Furthermore, the number of SME borrowers reported by CRC does not include any smaller non-deposit- taking FIs, such as smaller leasing companies that use lease receivables to borrow. At the end of June 2011, there are 7234 unincorporated borrowers that had registered transactions with CRC, of which some are likely to be SMEs and are not included in the analysis above. As a means to triangulate these figures, the evaluation team used IFC definition of SMEs to verify the share of transactions that reach SMEs. IFC has a standard SME loan size of USD 2 million and below. Applying this methodology, we found that 62% of the transactions can be classified as involving SMEs. This can then be estimated by multiplying it with an approximate loan size. USD 530,000 is a median loan size among SME transactions recorded in five cities in the CRC database. Using this methodology, the resulting estimate of the amount of financing extended to SMEs is USD 126 billion. The difference between our finding and the amount reported in the registry is likely due to the differences in the definition of SMEs in China (see below) and IFC. 46 Figure 4.19 China State Statistics Bureau’s definitione 31: Employee Annual turnover Total assets (million RMB) (million RMB) Sector Large Medium Small Large Medium Small Large Medium Small Manufacturing >2,000 300-2,000 < 300 >300 30—300 <30 >400 40-400 <40 Construction >3,000 600-3,000 <600 >300 30—300 <30 >400 40-400 <40 Wholesale >200 100-200 <100 >300 30—300 <30 Retail >500 100-500 <100 >150 10-150 <10 Transport >3,000 500-3,000 <500 >300 30—300 <30 Postal >1,000 400-1,000 <400 >300 30—300 <30 Hotel and >800 400-800 <400 >150 30-150 <30 catering Figure 4.20 Percentage of enterprises classified as SMEs by IFC proxy definition Percentage of enterprises whose loan size are below Registered SME loans involving accounts receivables certain level (2007Q4-2011Q2) (2007Q4-2011Q2) Percentage of enterprises whose loan size are below certain level City SMEs Large enterprise City Loan size (USD) Median Sample Median Sample <3,000,000 <2,000,000 <1,000,000 <500,000 <100,000 loan size Size loan size Size Beijing 61% 55% 41% 25% 8% Beijing $604,915 440 $6,254,457 359 Chengdu 63% 57% 44% 28% 2% Chengdu $574,669 544 $6,575,803 402 Hangzhou 80% 75% 61% 47% 17% Hangzhou $302,457 736 $4,536,862 243 Wuhan 65% 59% 42% 23% 3% Wuhan $718,336 542 $4,536,862 382 Zhengzhou 71% 66% 47% 24% 2% Zhengzhou $756,144 191 $4,536,862 101 Total 68% 62% 47% 31% 7% Total $529,301 2,453 $5,897,921 1,487 Source: Dalberg analysis of Private Registry Data. Credit Note: 190 loans do not record their loan size. Reference Center. Source: Dalberg analysis. Credit Reference Center. Source: Credit Reference Center (CRC) The SME survey revealed that almost all of firms obtained their A/R loans for working capital purposes, and none of them obtained loans for the purpose of debt repayment. Also, all of these SMEs are private enterprises, and almost 80% of them are in manufacturing and wholesale/retail/trading sectors. Approximately 20% of them are fewer than five years old. These enterprises are considered SMEs based on IFC’s proxy definition (i.e., loan size less than USD 2 million)39. Most of them (90%) also met IFC’s definition in terms of employee number (<300), although many of them (34%) did not meet IFC’s definition in terms of annual sales (30% above benchmark rate for the loan; 2.4% of total loan amount for CGC-backed guarantee Structuring of A/R financing Deal structure A/R management A/R debtor CGC A/R verification and monitoring Services / Accounts Third-party products receivables guarantee (A/R) Group mutual guarantee Sichuan Tianyue Chengdu Rural Industry Co., Ltd. Commercial Bank Secured loan Tianyue lacks acceptable collaterals: A/R represent the majority of Tianyue’s assets. The enterprise does not own real property. Its equipment and inventories are also limited. Asset selection and However, Chengdu Rural Commercial Bank does not accept A/R from Tianyue as security, monitoring and prefers third-party guarantees in this case. In addition to providing group mutual mechanisms guarantee, Tianyue provides a company guarantee by affording the service of CGC. CGC accepts and monitors A/R as security: CGC selected a number of A/R, and verified their validity of their debtors. While the Property Law does not require lenders to verify the pledged A/R with the debtors, this step is part of CGC’s monitoring mechanism. From a borrower’s perspective, the verification practice may be troublesome to its business partners and even signal doubts about their creditworthiness. 40 Note: Group mutual guarantee refers to an agreement among a number of enterprises through which each enterprise provides a third-party guarantee to all of the rest of the enterprises. 54 Impact Grow the operations: Tianyue grew its business from RMB 129 million in sales in 2008 to RMB 208 million in 2010, and hired 15 more management employees, 30 more temporary Benefits brought workers and 100 more installation employees in the same period. Tianyue’s ability to access by access to working capital is a pre-condition to achieving this growth. While Tianyue continues to back movables 30% of its borrowings through group mutual guarantee, it grew its outstanding borrowings financing… 3x in this period by using its A/R as counter-collaterals for CGC. Increase contract size: Tianyue has been able to take on contracts valued at above RMB 10 million. Previously RMB 10 million was an upper limit of contract size because Tianyue would not have adequate working capital to pre-purchase materials necessary to start production. Removing this upper limit has allowed Tianyue to work with new clients since the beginning of 2009. Incur higher financing costs: Tianyue would have to choose between two unfavorable options. It either incurs higher financing costs for a smaller amount of borrowings or halts What if movables the growth of the business. Higher financing costs would likely involve using shareholders’ were not accepted personal assets, paying higher fees for third-party guarantees, and raising funds from as security… informal channels. Lost upgrade opportunities: Without the ability to use movables as collateral, Tianyue would not have been able to strike a business agreement to service the western area of the Chengdu Shuangliu Airport Economic Development Zone. Also, Tianyue would not have been able to invest as much resources and time in product development. Previously, Tianyue had to focus its effort on business development because it did not have the working capital to accept large contract and had to win a greater number of small contracts. 4.4.3 Impact of movables financing on job creation As a group, the surveyed SMEs that received A/R financing clearly increased their workforce in 2011. Their median and average growth rates are 7% and 36%, respectively. However, IFC’s nationwide program and PBOC’s nationwide policies provide no scope for a control group41. The Project’s outcomes—passage of Property Law and creation of a single security interest registry for A/R in 2007, as well as an awareness campaign—are national in scope; they influence the entire country. A lack of comparable data on movables financing across countries also prevented us from using a synthetic control method.42 This is not to mention the challenge one would face to synthesize a country that is comparable to China given the uniquely large scale of the Chinese population and market. Therefore, we need to employ a reflexive method to compare SMEs with themselves before and after the Project. However, the analysis of the job creation impact is constrained by two factors: no access to SMEs from the 2004 baseline survey and the high refusal rate by SMEs in the 2011 evaluation survey.43 Lacking 41 Source: Handbook on Impact Evaluation - Quantitative Methods and Practices, by Shahidur R. Khandker, Gayatri B. Koolwal and Hussain A. Samad, IFC 2010. 42 More detailed discussion on synthetic control methods can be found at: Abadie, Alberto, Diamond, Alexis and Hainmueller, Jens, Synthetic Control Methods for Comparative Case Studies: Estimating the Effect of California's Tobacco Control Program (January 2007). 43 56% of the 3591 SME samples either were closed / moved or have changed their contact information. 8% of the remaining samples were successfully interviewed. See more detailed discussion in Appendix C 55 access to the baseline SMEs prevented us from conducting a longitudinal study. The high refusal rate reduced and ultimately eliminated the possibility of interviewing a sizable number of sample SMEs that can provide us with their financial and operational information prior to 2007. The 2007 information typically was not available to the SMEs we managed to reach and interview. The following evaluation method with which we experimented failed to provide statistically sound results regarding the Project’s impact on job creation. From the survey, we created two samples of SMEs, which were intended to be as similar as possible at the aggregate level with the exception that one group had early exposure to A/R financing and the other did not. These samples were matched along nine dimensions and the treatment group (early adopters) ended up with 38 sample SMEs versus the control group's 50 SMEs. In none of the estimates was the regression a significantly better fit than randomness at the 90% confidence level of F(5,88). Furthermore, revenue growth in 2009-10 was lower, on average, in the treatment sample. Employee growth saw similar results. This result echoes what we found by simply comparing the averages of revenue growth across the two samples. The tenuous implication of this finding is that early exposure to A/R financing may have been associated with some other (latent) variables that reduced revenue growth, since there may not be a direct negative effect of A/R financing on revenue. In addition, there may be important differences in unobserved variables with this kind of matching at the aggregate level. Unlike pairwise matching, the samples are of different sizes, but more importantly, the individual SMEs can actually be extremely different from each other and still match at the aggregate level. The matching process could also throw up different test and control samples if repeated. (See more detailed discussion on Appendix E). 5 Efficiency The efficiency ratio of this Project is remarkably high due to the unusually large scale of the Chinese economy. The Project has spent USD 1,539,168 since inception, but the amount of financing facilitated in China is many times greater. For example, approximately USD 3.5 trillion of A/R financing has been registered between October 2007 and the end of June in 2011. This unusually high efficiency return is primarily driven by the size of the Chinese economy, which is the second largest in the world. Similar projects in other countries cannot be expected to achieve similar results. Client in-kind support and swift fund deployment contributed to the Project’s efficiency from early on. According to interviews with donors, PBOC’s contribution allowed for more training sessions and advisory services to be completed than otherwise would have been possible. These activities are important to promoting industry awareness of the new instrument of A/R financing. PBOC’s contribution was remarkable as it was done in 2004 when IFC did not have a co-financing requirement for beneficiary governments. The in-kind and parallel contributions estimated by the IFC team are conservative estimates including costs of workshops, conferences, local transport, software development, etc. The Project team acknowledges that the Chinese authorities made significant investments in other areas relating to the Project such as the premises for the registry, staffing for the registry, publicity and media campaigns, and the operation of the actual registry. 56 IFC also leveraged experience learned from this Project to develop IFC’s secured transactions product line, which added to the return of this pilot project. As IFC’s pilot project on secured transactions reform, the Project absorbed some research and development costs of building a product line for IFC. IFC’s secured transactions and collateral registries program now has an active operational portfolio of more than 20 projects. Figure 5.1 Expenses, funding sources, and budget USD 1,896,834 USD 1,539,168 Client in-kind Unsecured USD 800,000 contribution budget and parallel support (USD 800,000) USD 95,000 IFC pooled USD 100,000 FIAS SECO USD 438,320 PEP China pooled Secured budget (USD 1,096,834) USD 463,514 CPDF pooled Actual Funding sources expenses to-date Source: IFC Advisory Services Supervision report 2011 Q2 Supervision # 11 6 Sustainability The key project outcomes are likely to endure as the Chinese government and the banking sector continue to modernize the secured transactions system in China. The new Property Law in China is one of a series of legal reforms undertaken by President Hu Jintao and Prime Minister Wen Jiabao. The concept of the new law was born with the drafting of a new civil code, a symbol of China’s great economic transformation. The need to modernize collateral laws also gained impetus when the Supreme People’s Court rendered an “Interpretation Concerning Several Issues Relating to the Application of the PRC Security Law” in 2000, recognizing the need to bring the 1995 Security Law more in line with modern secured transactions practices.44 44 Source: from China’s new Property Rights Law—an important step toward improving access to credit for small and medium enterprises by Valerie Marechal, Pelin Tekin & Humay Guliyeva, World Bank. 57 The Property Law was passed on March 16, 2007, with 99.1% of NPC’s 2,889 legislators backing it, even though the drafting of the law suffered setbacks and delays as a consequence of political debate.45 Since then, there have been no signs of other setbacks, according to stakeholder interviews. The PBOC and the Supreme People’s Court, with ongoing assistance from the Project, are working together to clarify aspects of the law and improve the legal framework for secured transactions through judicial interpretations. These judicial interpretations will help make the law more useful in practice, by clarifying the court’s view in given situations, and thereby ensuring the law’s sustainability. CRC, a public service unit within PBOC, is the host of the new registry. Based on meetings and interviews with CRC and PBOC staff, there are no signs that CRC is likely to face financial and operational difficulties in the foreseeable future. From an operational standpoint, there is 1-2 full-time equivalent staff who maintain the registry service throughout the year, and up to 5 full-time equivalent staff who organize special events related to the registry. CRC actively promotes its business and has plans to improve the design and features of its Web portal. Since October 2010, it has also started charging a small flat fee— RMB 100—for its registration service, which should help maintain its future financial sustainability. Besides the development of a law and the CRC Registry, the Project’s third outcome of increasing public awareness and industry capacity to engage in movables financing will likely sustain. News articles and advertisements about movables financing is now commonplace. The Project has documented numerous such news clipping. Also, all of the 50 FIs we surveyed either have already engaged in movables financing or are considering entering this market. 7 Replicability and Lessons Learned The Project’s choice of a reform partner and its positioning, timing, and team composition are its key success factors. We identified four replicable lessons for IFC’s global secured transactions program based on the Project team’s reflections: partnering with a politically powerful agency with market knowledge and administrative capacity, positioning the reform as the creation of a market, merging local knowledge with global subject-matter expertise, and sustaining a professional team over time. 1. Partnering with an agency that not only has political clout, but also understands the credit market and has a broad network of regional offices. IFC’s partnership with PBOC, the regulator of Chinese banks, was effective and created alignment early on. PBOC is a strong local champion for reform efforts and expanding SMEs’ access to finance more broadly.46 It plays a central role in making and implementing China’s monetary policy and safeguarding the country’s financial stability. The PBOC has working relationships with FIs in China and also commands respect from the various ministries and commissions at the highest level. The Chinese government has written the imperatives for movables financing into a series of policies and directives at the highest level since 2006. PBOC’s 45 Source: Ibid. 46 Source: IFC interview. 58 understanding of the credit market also facilitated the use of international best practice for the design of the CRC registry. PBOC’s ability to make decisions and implement them is another positive factor. For example, the Research Institute of Finance and Banking, IFC’s working partner within the PBOC, was capable of directing its research effort related to the reform. The PBOC also has the financial resources to develop a registry system. Finally PBOC’s nationwide network of regional branches has been instrumental in facilitating effective outreach and awareness among FIs throughout the country. For example, PBOC’s regional branches have worked with local governments to pass ordinances requiring larger debtors to comply with verification requests of A/R. 2. Positioning the Project as the development of a market rather than on any one specific reform. The European Bank for Reconstruction and Development (EBRD) is one of the pioneers on secured transactions reform. It had helped 22 of its 26 countries of operation create laws permitting non- possessory security over movable assets by 2000.47 Based on 10 years of experience, EBRD claimed that “new commercial and financial laws and regulations must be used by the business and banking community, applied by regulatory agencies and enforced by the judiciary.”48 The Project took this lesson to heart from the beginning. For example, the Project broke ground by working with PBOC—a central bank and a superintendent of banks.49 The Project included capacity building of FIs and the Chinese government in the scope of its three-pronged programmatic objectives. This sets it apart from the traditional view of seeing collateral reform as a purely legal project. The Project actively engaged the financial community as well as State Council, China Banking Regulatory Commission, National People’s Congress (NPC), and existing agencies that operate various security interest registries in the reform process. The Project’s design and implementation reflects the understanding that a law will not solve all the problems: a successful market development and reform requires efforts on multiple fronts including administrative reform, judicial reform, as well as capacity building of the industry. Lastly, China’s movables financing market has sprung up in the context of an imperfect property law. It is a testimony to the importance of creating a market as well as a legal and regulatory reform. 3. Investing to build a network of experts on both global and local levels so that the banking industry as well as government authorities are informed stakeholders. Consistent management support of a tripartite team of global (IFC Business Line), local (IFC Chengdu office), and government (PBOC) members has contributed to effective management and dissemination of knowledge.50 In addition to media campaigns and training programs, the Project also documented international best practices and product innovations, and translated them into Chinese. These materials have been 47 Source: Ten years of secured transactions reform, Law in Transition, Autumn 2000. 48 Source: The EBRD's legal reform work: Contributing to transition, Law in Transition, Autumn 2002. 49 Note: Reforming Collateral Laws to Expand Access to Finance by Heywood Fleisig, Mehnaz Safavian, Nuria de la Pena, published by World Bank, P.82-83: “Yet in the countries that have undertaken secured transactions reform, these entities [central banks and superintendents of banks] have never initiated the reform program”. 50 Source: “Secured Transactions Reform in China: Lessons and Experience” Jinchaing Lai Presentation to FinNet, October 19, 2010. 59 crucial in not only educating FI managers, but also in raising the credibility of movables financing in the eyes of the decision-makers at FIs. FIs, in addition to PBOC, are key drivers of reform advocacy and product innovations. This investment in knowledge creation has led to a change of lender attitude on many levels, according the experience of the Project. For example, movables assets, in addition to real estates and guarantees, have become acceptable security not only legally but also culturally. Asset-based lending is becoming a credible lending technology in the way that financial statement lending already is. SMEs, in addition to large and state-owned enterprises, have become target clients of commercial lending, by virtue of their movable assets. 4. Sustaining a long-term effort with a professional and service-oriented project team. The impact of building or reforming a country’s financial infrastructure takes years to materialize. Mr. Jinchang Lai, the head of IFC’s Chengdu office, has been involved in the reform process since 2003 when there were hardly any studies on movables lending in China. He has been a “glue” to sustain a team of global and China-based IFC staff members with counterparts in the Chinese government. IFC’s continual funding from 2004 to 2011 has given the team continuity, which allowed the team to comprehend the needs and constraints of the reform’s stakeholder group, and to understand how best to serve it. Various ministries, judiciary, FIs and banking sector associations, and existing registry operators stand to gain or lose from the outcomes of the reform, so they influence change or fight for the status quo. The Project team’s ability to build a working relationship with this diverse group of stakeholders has been critical to the effective implementation of the Project. Various stakeholders in the Chinese government stated that all their expectations of the Project team had been met. Figure 7.1 Project timeline (2003—2011) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2009: CRC launches 2006: Financial lease security registry institutions pilot lending 2003: IFC start to against movables discuss with PBOC conducted in Jiangsu about developing non- and Zhejiang real estate based financing market 2010: China Financial March 2007 : National Times and PBOC publish two case study books on People’s Congress passes movable financing in Property Law China October 2007 : Property Law becomes effective PBOC publishes a book on movable finance and CRC launches A/R practices in China Registry Source: IFC The success of the Project Implementation can also be attributed to a factor that cannot be replicated easily in other countries: the decision to launch and continue operations during a time when the broader Chinese economy underwent unprecedented levels of growth and development. The growth of the Chinese economy has resulted in more SMEs seeking financing to grow their business. The state- owned banks in China have begun to restructure after China’s accession to WTO in the early 2000s. The 60 banking sector has become increasingly responsive to market demand in the following decade and is now one of the most competitive markets in the world. Given the pressure that banks are under to lend and to serve SMEs, establishing the framework of movables financing opens a “release valve” of liquidity in the market. The timing of banking sector reform and economic growth creates unprecedented gravity toward updating the Security Law of 1995. By the same token, success of future projects in other countries will be significantly affected by the timing of project launch. For example, if a country is perceived to be in the process of building up a credit bubble or has just emerged from one, its legislature can be suspicious of any legislation that can be construed as facilitating lax lending practices. Its bankers can also be averse to any new instrument of financing. IFC has to bear greater risks when launching a project in an unfavorable macroeconomic time and expect a longer timeline (and bigger budget) to achieve its target outcomes. Figure 7.2 China’s economy was in a period of high growth China nominal GDP (Trillion USD) USD 5.0 T USD 4.5 T USD 3.5 T USD 2.7 T USD 2.3 T Annual real GDP 2005 2006 2007 2008 2009 2010 growth rate China 10% 12% 13% 9% 9% 10% Brazil 3% 5% 7% 1% 5% 5% United States 3% 3% 2% 0% -3% 3% Source: Bloomberg Indices We also assessed the monitoring and evaluation design for the Project, and highlighted below four recommendations on metrics and methodologies for potential improvement.  Enable the host of a security interest registry to collect and disseminate statistics (IFC had already implemented this measure before this evaluation was conducted). The paramount task of a modern security interest registry is to lower the costs of establishing priority over security interest. However, we observed that the statistical data compiled and released by CRC not only helped us evaluate the impact of the IFC Project, but also provided the media with information on the growing size of A/R financing. These statistical data become valuable resources to promote awareness and support policy-making. We recommend that future projects consider enabling the host of a security interest registry to collect and disseminate statistics. For example, future projects can assess the information management capacity of the host, suggest it require certain information be supplied when a bank registers its security interest (e.g., contract value), and charge a nominal fee to reduce instances of repeat and careless registrations. 61  Measure the “credit culture” of FIs as a project outcome. A banking system is more efficient when lenders are more capable of assessing credit risks. A modern commercial bank evaluates the underlying business and cash flow of its borrowers and treats security interest as a signal instead of a piece of property to be seized in case of default. However, the Project team observed that one barrier to lending in the Chinese banking system has been the FIs’ distrust of private firms. This proclivity is a reason why some bankers emphasize the importance of having immovable assets like real estate as collateral. Establishing a modern credit culture requires new conceptual understanding and institutional capacity, both of which the Project has promoted but rarely measured. We recommend that future projects assess baseline credit culture specific to a country and use it to guide the content and target outcome of their capacity building effort.  Measure the impact of a secured transactions program by tracking changes in FIs and SMEs over time. Creating the instrument of movables financing in a country requires a change in its legal and regulatory framework, a low-cost mechanism to establish priority over security interest, and new capacity and awareness of its commercial banks. Often these elements will affect the country as a whole and thus benefit all comparable enterprises in a country. In another word, the entire country becomes a treatment group. Particular sectors or locations within a country that continue to lack access to A/R financing are likely deemed as unfit markets for business reasons. It is therefore difficult to construct and argue for a control group that is simultaneously as qualified as the treatment group from a business standpoint, and yet lacks exposure to A/R financing. Keeping track of same FIs and SMEs before and after the intervention provides a better control group. It also avoids creating a bias toward surviving entities. We recommend that future projects keep track of the FIs and/or SMEs surveyed in the baseline survey and build in questions for a potential post-project evaluation.  Opportunistically measure the impact on SME survival in times of liquidity crunch. Almost all A/R financing is used for working capital purpose in China according to the survey of 126 enterprises in five cities. Solvent businesses use working capital to meet their short-term obligations, such as paying their bills, employee salaries, and loans. Enterprises need a larger amount of working capital to expand their businesses in times of growth. In normal times and especially during times of liquidity crunch, they need access to working capital to keep their businesses afloat. In one of the interviews with a Chinese entrepreneur, he recounted how he had to sell his steel production business in 2008 because of the credit crunch. No banks were willing to lend to his business and accept its inventory assets as collateral. He is now more confident that his new business will have a better chance to survive the next liquidity crisis because his current banks are willing to accept movable assets as collateral. We recommend that future projects consider using bankruptcy rates and potential jobs saved, when applicable, as a metric for their impact on SMEs. 62 8 Future Development of Movables Financing in China Access to finance is a critical challenge for SMEs around the world, particularly in times of economic crisis. Formal SMEs typically represent 45% of national employment and 33% of GDP in developing countries. However, these businesses face considerable challenges accessing the finance that they need to grow and to meet their working capital needs. A lack of collateral remains one of the key constraints facing firms in emerging markets when they attempt to access financial capital. Recent data from the World Bank Enterprise Surveys indicates that insufficient collateral was cited by 70% of respondents in the East Asia Pacific Region who had recently had credit applications rejected, while another 20% of respondents in the region did not even apply for credit because collateral requirements were too high51. PBOC, with IFC’s assistance, has “unlocked” movable assets typically owned by SMEs and made them increasingly instrumental to SMEs’ access to finance. In developing countries, 78% of the capital stock of a business enterprise is typically movable assets such as machinery, equipment or receivables, and only 22% immovable property. 52 But IFC estimated in 2004 that private firms, SMEs and farmers in China owned more than 16 trillion RMB of assets that could not be used to generate loans to fund business investment and growth.53 This situation has begun to change. The value of outstanding commercial loans exclusively secured by movable assets grew from 800 billion RMB at the end of 2006 to 3.8 trillion RMB by the end of 2010 based on the survey of 50 FIs. The CRC registry has also recorded 385,000 registrations of security interest in A/R since October 2007. However, movables financing remains an emerging channel of financing for enterprises in China. The share of commercial portfolio of outstanding loans secured exclusively by movable assets was 17% in 2010 according to the survey of 50 FIs. The majority (83%) of the FIs’ commercial portfolio continues to be secured by other forms of assets. While this is very different from what one would observe in countries like the United States, Canada and the United Kingdom, this is to be expected. Only four years have passed since the passage of the Property Law and the creation of a single registry for security interest in A/R in 2007. It is also likely that these numbers underreport the actual amount of movable financing because of the prevalence of using various forms of assets to secure a loan (e.g., combining movables and guarantees) which this study was not able to disaggregate. FIs and government authorities can facilitate capital deepening and greater product sophistication based on the perspectives they have shared with us through interviews. Capital deepening refers to greater financial capital share per worker and it contributes to greater productivity of the economy. Product sophistication refers to a greater availability of movables financing products tailored for different needs of SMEs from different sectors. The Project’s three objectives—improving the legal and regulatory framework, lowering the costs of establishing priority over security interest, and building the capacity of FIs—are believed to be equally important in the future development of movables financing 51 Source: World Bank Enterprise Surveys. 52 Source: Ibid. 53 Source: Source: Reforming Collateral Laws and Registries: International best Practices and the Case of China (March 2007), IFC. 63 in China. Stakeholder interviewees highlighted some measures below that can contribute to these objectives: 1. Improve the legal and regulatory framework of movables financing through judicial interpretation. There are many areas of uncertainty that require further clarification. First, whether creditors have priority over “super” authorities, such as tax authorities, on security interest. Second, whether creditors have the right to enforce their security interest in an economically efficient manner. Third, which party has priority in the event that a borrower had a contractual agreement with its debtor not to pledge its A/Rs as collateral? Fourth, how to establish priority in the event that pledged assets are transferred. We learned from our meeting with a Supreme People’s Court judge that the court, working with PBOC, planned to issue judicial interpretations to clarify issues like these, either preemptively or as they arise. 2. Lower the costs of establishing priority over security interest in equipments and inventories by merging related registries. The AIC can consolidate its registries and follow the operating principles (e.g., the resulting registry does not conduct substantial review of registrations) as intended by the Property Law in 2007. The Project team believes that it is unlikely for one consolidated registry for security interest of all movable assets to emerge in China. However, the two registries hosted by CRC and AIC, respectively, can still be linked online to reduce the FIs’ transaction costs of accepting movable assets as collateral. 3. Increase FIs’ capacity by adopting and innovating lending technologies. FIs can continue to improve their methods of evaluating credit risks and monitoring their security interest in movable assets. For example, commercial banks can develop real-time information systems to access the timing and amount of receivables owned by their creditors. Also, new technologies in warehouse inventory monitoring, A/R verification, and electronic platforms can emerge. Third-party firms that offer these services to FIs can accelerate the innovation process because they are required to be ahead of the commercial banks in these capacities. We met with one inventory monitoring service firm called Southwest Railway Storage and Transportation. It had grown from serving one FI in 2007 to serving 12 in 2011, and monitoring inventory on behalf of three warehouses in 2007 to 87 now. As a way to mitigate risk and better monitor financial flows of the borrower, lenders in countries such as Canada only permit their SME clients financed by A/R to have one designated current account. We also found that an educational campaign can potentially boost the business community’s awareness of the benefits of movables financing. For example, FIs perceive A/R financing as a particularly risky product, while this product’s default rate suggests the contrary. Among the 20 FIs that provided estimates in the survey, the default rate of A/R financing is lower than immovables financing and guarantees, except in two cases where the default rates are estimated as equal. Many SMEs are also unaware of the possibility of using A/R as collateral. According to the survey of SMEs that are already located in the tier-one city of their respective provinces, 84% of them that have not recently used A/R as collateral and could not mention A/R as a potential source of assets for collateral purpose. 64 IFC is positioned to provide follow-on services to the Chinese government given the success of the first project. However, the extent to which IFC will involve itself in these future developments of movables financing depends on its regional and global strategic priorities. The China project, as one of the first of its kind, has shaped IFC’s product on secured transactions systems. Regardless of IFC’s engagement in China, this product will continue to improve and evolve as IFC becomes more experienced in offering it in other countries and regions. 65 9 Appendices Appendix A: Financial Institution Case Studies Case I: Very Large FI Introducing Movable Lending at Nationwide Scale Overview This FI is a joint-stock limited company that has a relatively large share of the market. They serve a large volume of clients nationwide. This FI has a strong commitment to lending to SMEs. For example, they published a commitment with All-China Federation of Industry & Commerce to maintain SME lending annual growth of RMB 140 billion, targeting balance of RMB 1.1 trillion by 2015. They also have specialized sub-branches for SMEs and SME service centers, in addition to special SME credit rating authorization policies. In terms of the types of lending products they offer to SMEs, they have small enterprise revolving loans and supply chain financing, among other things. Overall this FI can be characterized as having very high capacity for product development and a nationwide network of branches to facilitate large-scale rollout of new products. Experience with movables financing Adoption of movables financing. The FI started developing movables financing products in 2005. At that time, the products were not called movable-based financing, but rather transaction-based or trade- based financing. The initial products in 2005-2006 were for international trade financing. Since 2005, the volume of movables financing has increased dramatically, with A/R financing accounting for 80% of the current portfolio of movables financing. The majority of lending using these products is now for domestic trade finance. The FI accepts several types of movable assets, including purchase orders, contracts, A/Rs and inventory. The FI is now developing new forms of movable lending including, including products based on pledge of equity stakes, copyrights and intellectual property. Product Innovation. Generally, the headquarters does much of the product development. However, the FI recently gave innovation authority to provincial level branch management, to enable more tailored product development customized to local markets. Products developed at the province level are then shared with headquarters for approval and replication in other regions. byproduct innovation processes typically start with studying client needs and demands. By first understanding their key needs, challenges, and business opportunities, the FI develops customized lending products. Practices of other competitors in China are other key sources of inspiration for new product development. Smaller FIs are viewed as a source of innovation for more specialized lending products in industries such as agriculture, or specialized forms of inventory financing. Best practices of banks in other countries are another source of information for product innovation. The FI noted that the various conferences and awareness-raising 66 events organized by Chinese regulatory authorities / World Bank are helpful sources of information on emerging best practices from within China and internationally. Lending practices. The FI engages in a broad range of movables financing, including A/R, Inventory, and Equipment. The FI is a very frequent user of the A/R Registry to understand the information about borrowers and to publicize information to other FIs. Branch staff are required to check the A/R registry to determine if there is prior interest on an asset prior to approving a loan. When considering A/R financing for SMEs, there is a preference for financing receivables from borrowers that supply goods and products to large enterprises. While receivables from SMEs and medium-sized firms are accepted, the FI will often conduct additional verification and in some instances require insurance. Interest rates for movables financing tend to be slightly higher than with real property-based financing because of the additional costs of verifying and monitoring movable assets. A/R Lending Snapshot Year adopted 2007 Lending value or limit Depends on the quality, financial strength of the counterpart on loan size Good quality = 100% Low quality = 70% Average = 80% Default rate (%) n/a Recovery rate on n/a default (%) Current practices for Financing on the basis of a specific receivable SME clients Financing on the basis of multiple A/Rs = Frequently Financing on the basis of receivables from large companies = Occasionally =Infrequently Financing on the basis of receivables from SMEs Fees associated with There are some minimal fees, but the FI recovers costs of this type of lending these types of loans through imposing slightly higher interest rates. 67 Inventory Lending Snapshot Current practices Standard warehouse receipts = Frequently Nonstandard warehouse receipts = Occasionally Pool of current and future inventory =Infrequently Average advanced rate % 51% Monitoring. A variety of methods are used to monitor movable assets. For A/Rs, the security interest is frequently verified by contacting the debtor at the initiation of the loan. This verification process is an important part of determining the lending value. Throughout the life of the loan, clients are asked to send regular reports usually on a monthly basis. If the value decreases, the FI requires the borrower to either pledge additional A/Rs or repay the loan. The FI uses an electronic monitoring system to keep track of when the A/R should be collected. For all inventory financing, a third party is involved in the monitoring process. For inventory, the FI uses a combination of clients submitting regular reporting on inventory levels, having loan officers visit client sites, and third parties to monitor the inventory. Impact of adopting movables financing on lending activity The FI stated that movables financing has been critical to their recent growth. Until recently, the FI had derived a large share of its business through infrastructure and real estate financing. However, recent analysis performed by the FI revealed to them that China’s economic development is evolving, and with it the financial needs of the economy are also changing. Infrastructure development is expected to stabilize, while other sectors such as manufacturing, wholesaling, retailing, and distribution are growing in relative terms. These businesses require fundamentally different types of financing—often smaller, more frequent transactions rather than large up-front financing loans. From the FI’s perspective, transaction-based financing is an attractive way to diversify their business portfolio and build a more reliable stream of revenue. These lending products rely upon the ability to finance movable assets. As a result, movables financing now plays a critical role in the FI’s growth and product offerings. 68 Figure 9.1 Changes in volume of lending secured by movable assets, as a share of the total volume of lending Share of the Lending Volume of Commercial Loan Portfolio Secured by Movable Assets 36% 16% 13% 2006 2008 2011 Source: 2011 IFC FI Survey 3 Implications for SME lending The FI stated that movables financing offers them a way to better serve SMEs. Two of the key challenges that the FI encounters when lending to SMEs are a lack of collateral, and concerns that SMEs may use the capital obtained for the loan for unintended uses (i.e. using it to fund existing operations vs. capital expansion). Movables lending solves for both of these challenges by enabling a broader range of assets to be used as collateral, as well as providing greater transparency into the SME’s finances to ensure that the loan is being used for appropriate purposes. The representative for the FI stated that movables financing has been a critical part of the FI’s expansion into serving SMEs in the manufacturing, trade, and construction sectors. The interviewee from the FI stated that a key driver of the FI’s adoption of movables financing is the opportunity to decrease the risk of loan default, especially among SME clients. The interviewee observed that the risk associated with movables financing is lower than the real property-based financing. Movables financing enables the FI to have greater access to the borrower’s business performance, and is much more insightful for predicting the chance of loan default than the value of property. As illustrated in the figures below, in the period after the adoption of movables lending, the FI significantly increased both the number SME clients and the total lending volumes to SMEs. 69 Figure 9.2 Changes in SME lending activity FI 1 Commercial loan portfolio Commercial loan portfolio Number of SME clients as a % of total Indexed Growth in the Number of SME clients active clients Value in 2006 = 100 91 160 87 83 108 100 2006 2008 2010 2006 2007 2008 2009 2010 1 Source: 2011 IFC FI Survey Figure 9.3 Changes in SME lending volume FI 1 Commercial loan portfolio Commercial loan portfolio Volume of lending to SME clients as a Indexed Growth in the Volume of % of total portfolio Loans Outstanding to SME clients Value in 2006 = 100 60 260 44 45 130 100 2006 2008 2010 2006 2007 2008 2009 2010 2 Source: 2011 IFC FI Survey Key drivers of changes in SME lending. In both the qualitative interview and the subsequent survey, this FI stated that the passage of the 2007 Property Law was the most important factor that explained the increases in SME lending between 2006 and the end of March 2011. They described the law as a breakthrough that has had profound impact on the FI’s lending practices. The FI representative was very 70 complimentary of the workshops organized by IFC and PBOC as a way to obtain information on best practices. The quantitative results, however, are more nuanced. The table below shows that the growth in the volume of loans secured by movable assets accounted for 12% of all new finance extended to SMEs over the period 2006-2011. Of all the new SME clients that the FI acquired in 2006-2011, only 16% were using loans that were secured by movable assets. It appears that land use rights continue to be the main form of security interest used in SME lending. However, of all the asset classes, movable assets are the fastest growing form of collateral. So these results can be interpreted as one snapshot in a journey that is likely to evolve as the FI gains even more experience and expertise in this form of lending. Composition of new finance made Composition of new SMEs clients available to SMEs between 2006-2011 2006-2011 (Volume of Loans as a Share of the Total) (Number of Clients as a Share of Total) Credit loans, unsecured 42% 23% Loans exclusively by guarantee 16% 23% Loans exclusively by land use rights 29% 38% Loans exclusively by movable assets 12% 16% Source: 2011 IFC FI Survey Considerations for the future The FI anticipates strong continued growth of lending to SMEs using movables financing. Going forward, some of the areas that would further enable the FI’s growth in this area include clarifying the rules of establishing priority over pledged assets. Some of the areas that the FI has been working through as they implement movables financing for SMEs are related to verification and monitoring of the assets. Confirmation from the debtors is a challenge to obtain. The FI has started to employ third-party monitoring companies, but as compared to the much more established real estate market, these third- party providers are still relatively new and less experienced. They are still working on improving and streamlining these processes. Unifying and modernizing registries for equipment and inventory was also cited as a desired next step in the evolution of movables finance. The representative from the FI also cited a need for registries for new forms of movable collateral, for example, intellectual property and copyrights. The idea of linking the A/R Registry to the FI’s credit system was also viewed positively. 71 Case II: Profile of an Innovative FI Overview This FI is a joint stock bank, and one of the larger FIs in China. Its branches are concentrated largely in the North and Eastern regions. This FI is known to be one of the more progressive FIs and a leader in product innovation. For example, it was one of the first FIs to implement Special Business Units (on key industries, products, customers) as organization model. Like many other FIs, the focus on SMEs is relatively new. Traditionally, the FI has focused on big enterprises and project financing. Recognizing the need to diversify and keep pace with competitors, however, the FI began focusing on SMEs in 2008. This FI now has a special business unit dedicated to serving SMEs. One of the key mandates of this unit is to develop customized products and services that serve the unique needs of SMEs. Experience with movables financing Adoption of movables financing. The FI began pilot programs involving movables financing in 2004, and has been offering factoring-based products since 2000. The FI officially launched A/R financing in 2008. The key motivation for adopting movables financing included (1) looking for ways to serve the SME market segment, (2) taking advantage of the new opportunities afforded by the 2007 Property Law, and (3) the fact that movables lending enabled the FIs to obtain more information and reduce risk. As of 2011, the FI accepts A/R, equipment, and inventories as collateral. As illustrated in the figure below, as of Q3 2011, the 47% of the FI’s total lending volume was secured—in full or in part—by movable collateral. FI 2 9.4 Changes in Volume of Lending Secured by Movable Assets, as a Share of the Total Figure Volume of Lending 100% 7% 11% 11% Movable Assets 11% Movable and Immovable 25% Collateral and Guarantee 35% Credit loans Guarantee Land Use Rights 55% 8% 31% 18% 12% 30% 27% 14% 1% 2% 2% 2006 2008 2010 Source: 2011 IFC FI Survey 4 72 Lending practices. The FI has adapted their credit scoring and lending processes for movable lending finance. They have established a formula for risk-based valuation and a model for conducting initial screening for clients. This model considers credit rating and the creditworthiness of the client and then applies the financing rate against the A/Rs. If credit is “approved,” the loan is subject to checks against the profitability requirements of the bank. The terms of repayment are usually based on A/Rs term dates. The credit limit for the client is adjusted to account for changes in the value of the A/R on a revolving basis. Historically, the FI considered real estate to be a less risky form of collateral, but with the advent of A/R financing, they view A/R as a better way to monitor the cash flow of the business. Receivables from larger debtors are preferred. The FI reported that they find it more challenging to accept A/Rs from rural and smaller enterprises due to challenges in verifying, monitoring, and managing the risks of those types of collateral. A/R Lending Snapshot Year adopted 2008 Lending value or limit 50-100%, depending on the value of receivables on loan size Default rate (%) 0.2% Recovery rate on n/a default (%) Current practices for Financing on the basis of a specific receivable SME clients Financing on the basis of multiple A/Rs = Frequently Financing on the basis of receivables from large companies = Occasionally =Infrequently Financing on the basis of receivables from SMEs Fees associated with n/a these types of loans Inventory Lending Snapshot Current practices Standard warehouse receipts = Frequently Nonstandard warehouse receipts = Occasionally Pool of current and future inventory =Infrequently Average advanced rate % 38% Monitoring. The FI uses a variety of methods to monitor movable assets. Of note is that they use a real- time database that links data from the borrower to FI’s records on a T+1 basis. This is the preferred 73 method of monitoring. In several branches, there are also dedicated staff that monitor assets such as inventory or equipment. A letter from the debtor is the most common method of verification. Implications for SME lending The FI’s adoption of movables lending was a critical factor in its ability to significantly expand into the SME lending market. As the figures below illustrate, the FI dramatically scaled up both the number of clients and the amount lent to them in the period of the evaluation. Figure 9.5 Changes in number of SME clients in the Commercial Loan Portfolio FI 2 Commercial loan portfolio Commercial loan portfolio Number of SME clients as a % of total Indexed Growth in the Number of SME clients active clients Value in 2006 = 100 57% 1.480 23% 11% 275 100 2006 2008 2010 2006 2007 2008 2009 2010 5 Source: 2011 IFC FI Survey 74 Figure 9.6 Changes in Volume of Lending to SME clients in the Commercial Loan Portfolio FI 2 Commercial loan portfolio Commercial loan portfolio Volume of lending to SME clients as a Indexed Growth in the Volume of % of total portfolio Loans Outstanding to SME clients Value in 2006 = 100 10% 260 130 100 4% n/a 2006 2008 2010 2006 2007 2008 2009 2010 6 Source: 2011 IFC FI Survey Key drivers of changes in SME lending. The FI reported that movables financing has played a significant role in enabling their ability to serve SME clients. In particular, the FI stated that they are using movables financing most frequently to serve SMEs in the wholesale and retail trade. The most important factor driving the FI’s adoption of movable lending is their desire to better serve SMEs. When reviewing the SME lending portfolio, the story is again more nuanced, in that ~12% of new lending volume and ~12% of new SME clients were financed using movables (in full or in part). The major driver of growth of SME lending appears to be the use of guarantees. Composition of new finance made Composition of new SMEs clients available to SMEs 2006-2011 2006-2011 (Volume of Loans as a Share of the Total) (Number of Clients as a Share of Total) Credit loans, unsecured 0% 0% Loans exclusively by guarantee 33% 42% loans exclusively by land use rights 14% 3% Loans exclusively by movable assets 7% 7% Movable and immovable 5% 5% Collateral and Guarantee 53% 43% 75 Appendix B: Interview List IFC recommended the interviewees below with few exceptions. The interview list includes government officials, FI lenders, SME management, donor representatives, independent experts and IFC stakeholders. The government officials are the various local partner organizations that work with IFC on this Project. Interviewees from FIs typically come from the SME Lending Department, Risk Management, and Legal Departments. We conducted all the phone interviews independently. The face-to-face interviews in China were conducted in Mandarin with the assistance of a specialist translator provided by IFC. Interviewee name Interviewee title/position Organization Location Government officials Ms. Ping Liu Deputy Director-General, Research Research Institute of Finance Beijing Fellow and Banking, People’s Bank of China Ms. Shaohua Zhang n/a Research Institute of Finance Beijing and Banking, People’s Bank of China Mr. Xiang Xiao n/a Research Institute of Finance Beijing and Banking, People’s Bank of China Mr. Yanfei Ye Deputy Director-General China Banking Regulatory Beijing Commission Statistics Department Ms. Jihua Hu Deputy Director-General (Civil Law Standing Committee of Beijing Department, Legislative Affairs National People's Congress Commission) Mr. Jianfeng Jin Director General Supreme People’s Court Beijing Mr. Wang Lu Deputy Director-General People's Bank of China, Credit Shanghai Reference Center Ms. Xinyan Xu Assistant General Manager People's Bank of China, Credit Shanghai Reference Center Mr. Sheng Wenjun Vice Department Head Hangzhou Branch, People’s Hangzhou Bank of China, Ms. Lou Guotao Vice Head of Branch People's Bank of China, Hangzhou Xiaoshan Branch Financial institutions Ms. Xuehui Zhao Manger, Credit Department China Minsheng Banking Beijing Organization Ms. Zuoting Tan Board Member, Head Operations Beijing Zhongguancuan Sci-tech Beijing Manager, Head Engineer Guaranty Mr. Jiangong Wang Vice General Manager Beijing Zhongguancuan Sci-tech Beijing Guaranty Mr. Xinbin Li Director, Trade Finance, Credit Industrial and Commercial Beijing Department Bank of China 76 Interviewee name Interviewee title/position Organization Location Ms. Jie Gao Vice President ICBC, Hangzhou Jiannan Branch Hangzhou Ms. Yanfei Feng Senior Customer Manager ICBC, Hangzhou Jiannan Branch Hangzhou Ms. Xinpeng Wang Client Manager ICBC, Hangzhou Jiannan Branch Hangzhou Mr. Guosong Yan General Manager Chengdu Small Enterprise Chengdu Credit Guarantee Ms. Aijun Chen Administration Vice Manager Chengdu Small Enterprise Chengdu Credit Guarantee Ms. Yalai Zhang Risk Management Department Chengdu Small Enterprise Chengdu Manager Credit Guarantee Mr. Zhengjun Zhang General Manager Chengdu Yinfeng Copper Co. Chengdu Mr. Zhongze Chen Vice President, Guarantee Chengdu Small Enterprise Chengdu Department 3 Credit Guarantee Ms. Shi Tang Project Manager, Guarantee Chengdu Small Enterprise Chengdu Department 3 Credit Guarantee Mr. Gusong Yan General Manager Chengdu Small Enterprise Chengdu Credit Guarantee Ms. Yalai Zhang Risk Management Department Chengdu Small Enterprise Chengdu Manager Credit Guarantee Mr. Minqing Yang Vice President Bank of Chengdu Chengdu Mr. Jian Zhang General Manager, SME Department Bank of Chengdu Chengdu Ms. Yaoxian Yuan Head of Shawan Branch Bank of Chengdu Chengdu Ms. Min Fan Credit Officer, Business Bank of Chengdu Chengdu Department, Shawan Branch Ms. Jianying Sun Deputy General Manager, SMEs Shanghai Pudong Bank Shanghai Mr. Li Zhu Business Management Department, Shanghai Pudong Bank Shanghai Small & Medium Enterprises Mr. Ronghua Xu Factoring, Trade Finance Shanghai Pudong Bank Shanghai Department, Corporate & Investment Banking Ms. Iris Liang Senior Vice president, Product HSBC Shanghai Manager Receivable Finance Mr. Roger Yao Associate General Counsel, HSBC Shanghai Corporate Banking Ms. Sylvia An Vice President Commercial Banking, HSBC Shanghai Receivable Finance Mr. Johnny Zhang Assistant Vice President HSBC Shanghai Commercial Banking Small- and medium-sized enterprises Mr. Huen Li General Manager Sichuan Laiyang Steel Pipe Chengdu Limited Co. Mr. Qinghui Xu Chairman, General Manager Chengdu Southwest Railway Chengdu Deposited And Conveyance Co. Ltd Ms. Xiaowen Yuan Production Management Assistance Chengdu Southwest Railway Chengdu to General Manager, Head of Deposited And Conveyance Co. Depository and Conveyance Ltd Mr. Tingyuan Tang Vice General Manager Chengdu Southwest Railway Chengdu Deposited And Conveyance Co. Ltd 77 Interviewee name Interviewee title/position Organization Location Mr. Feng Li General Manager Sichuan Logistics (Zhongfu) Chengdu Ms. Yun Ziong Finance Manager Sichuan Tianyue Industry Co. Chengdu Ltd Mr. Tianshui Tong Board Chairman, Adjunct Professor Zhejiang Yongjin Hangzhou Ms. Cifeng Chen Financial Settlement Manager United MetalTek Hangzhou Mr. JianFa Zheng Vice General Manager Heng Tian Group Hangzhou Donors Mr.Thorsten Giehler Programme Director-Financial GIZ (Deutsche Gesellschaft fur Beijing Sector Reform Internationale Zusammenabeit) Experts Mr. Jason Zhou Managing Director LeaseOne (Beijing) Beijing Management Consultants Mr. Mao Huang Deputy General manager / Chief Bank of China, SME Banking Shenzhen Risk Officer Department, Shenzhen Branch Mr. Everett Theodore Legal and registry expert Independent consultant Telephone Wohlers Mr. Ronald Cuming Legal expert Independent consultant Telephone Prof. Gregory F. Udell Asset-Based Lending Trainer for IFC Indiana University Telephone China events Prof. Shengping Gao IFC Event Speaker on Secured China Renmin University Telephone Transactions Mr. Johnson Chng Partner Bain & Company Telephone IFC Mr. Alejandro Alvarez de IFC Global Product Specialist, IFC Advisory Services Washington, la Campa Secured Transactions and Collateral D.C. Registries Mr. Jinchang Lai Head of Chengdu Office IFC Advisory Services Chengdu Mr. Alexis Diamond Evaluation Officer IFC Advisory Services Chengdu Mr. Matthew Gamser Regional Manager IFC Advisory Services Telephone Mr. Hyun-Chan Cho Country Manager, China and IFC Advisory Services Telephone Mongolia Ms. Lory Camba Opem M&E Officer IFC Advisory Services Telephone 78 Appendix C: Methodology and Summary Results of FI Survey The Financial Institutions (FI) survey was conducted on 50 FIs across China by the Research Institute of Finance and Banking, PBOC. 20 banks in China (Big 5 banks and 15 policy banks, large commercial banks, joint-stock banks) account for approximately 75% of the overall assets and liabilities of the banking sector54. 12 of these 20 banks were interviewed for this Project, including all of the Big 5 banks: Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China, China Construction Bank and Bank of Communications. The other seven of the 20 banks are China CITIC Bank, China Merchants Bank, China Minsheng Banking Corp, Evergrowing Bank, Guangdong Development Bank, Shanghai Pudong Development Bank and Shenzhen Development Bank. The FI survey thus represents a considerable proportion of the banking sector on the aggregate level by including these 12 banks in its sample. Figure 10.1 Chinese banking sector (2006-2010) by institution type Total assets Total liabilities (100 million RMB) (100 million RMB) 439,500 531,160 631,515 795,146 953,053 417,106 500,763 593,614 750,706 894,731 40 foreign banks 2% 2% 2% 2% 2% 2% 2% 2% 2% 2% 15 policy banks and large/joint 20% 22% 21% 22% 23% 24% 24% 23% 24% 24% stock commercial banks >3,000 local banks 22% 22% 23% 23% 22% 23% 23% 25% 23% 25% Five Big 5 banks 55% 54% 52% 51% 49% 55% 54% 52% 51% 49% 2006 2007 2008 2009 2010 2006 2007 2008 2009 2010 Apart from these large-scale banks, 33 local banks and five foreign banks were surveyed. The local banks are headquartered in the provinces of Shaanxi, Zhejiang, Anhui, Shanghai, Guangdong and Shandong, and operate in the SME-concentrated economic zones of Yangtze River Delta, Bohai Rim, and Pearl River Delta55. These three economic zones represent approximately 70% of the country’s SME sales revenue56. By selecting sample banks from these zones, the FI survey aims to reflect the geographic distribution of where SMEs do business and utilize banking services. However, the sample size (33) of local banks surveyed is very small when compared to the population size (>3,000). 54 Source: Dalberg analysis and China Banking Regulatory Commission Annual Report 2010 55 Yangtze River Delta includes Shanghai, Zhejiang and Jiangsu; Bohai Rim includes Beijing, Tianjin, Hebei, Shandong and Liaoning; Pearl River Delta includes Guandong 56 Source: PBOC 2008; Yearbook of China Small and Medium Enterprises 79 Figure 10.2 Sample and population size of the FI survey Institution type in Chinese banking sector Population size Sample size (n) % of total (N) (n/N) Big 5 Banks 5 5 100% Policy banks and large/joint stock commercial banks 15 7 47% Local Banks 3,709 33 1% Foreign banks 40 4 10% Source: Research Institute of Finance and Banking, PBOC, and China Banking Regulatory Commission Annual Report 2010 We attempted to evaluate the effect of a bank’s internal policy—accepting A/R as collateral by 2007— on its value and volume of SME lending based on the FI survey data. Because the FI survey does not have access to a random sample, we do not have a randomized controlled trial (RCT) from which to draw a rigorous conclusion. In place of an RCT, we estimated a "difference-in-difference" model where we compared the experience of test and control groups before and after the policy change. The test and control groups should be as similar as possible, with the only difference being that the test group adopted the policy change institutionally. We believe that the most similar groups are (1) those that adopted the policy change between 2007 and 2008, and (2) those that adopted the policy change after 2008. Also, the third group, (3) those that never adopted the policy change, may be substantially different from groups (1) and (2) and thus not a good control for our estimation. Unfortunately, when we drop banks with non-standard definitions of SMEs, the sum total of banks in groups (1) and (2) is 26. Four of these 26 did not report data on loan volumes in 2006. Using the remaining 22 banks does not yield a regression that is a better fit than randomness at the 90% confidence level. As a result, we conclude that it is not possible to rigorously estimate the effect of the 2007 policy change using the data available today. Filling in the missing data for the four banks mentioned above or adding more banks to the sample could solve this problem; the latter, however, should be done in as random or representative a fashion as possible in order to preserve rigor. 80 SUMMARY RESULTS—FI SURVEY A. BACKGROUND INFORMATION 1. Ownership structure Number of large Number of joint stock Number of local Number of foreign commercial banks banks domestic banks banks 5 8 33 4 2. Region of operation Region Number of banks Guangdong 8 Anhui 6 Shanghai 7 Shaanxi 7 Shandong 7 Zhejiang 7 Beijing 8 3. Criteria for designating clients as SMEs Number of Yes Number of No a. Standard definition as used by Govt. agencies(e.g. 42 8 China State Statistics Bureau) b. Other criteria 13 37 81 4. Minimum and maximum loan amounts used to classify SME lending activity Standard Max Min Median Mean Deviation a. The Minimum loan amount that qualifies as a 100 0 1 30 40 SME loan b. The Maximum loan amount that qualifies as a 5,000 10 3,000 2,467 1,662 SME loan B. OVERALL LENDING PORTFOLIO—BY TYPE OF CLIENT 1. Composition of the FI’s commercial client base over time—Number of borrowers (in ‘000) Type of FI's Standard Year Max Min Median Mean Deviation clients SME 439 0 1 1 74 2006 All others 138 0 0 0 26 Total 577 0 1 1 96 SME 126 0 1 1 23 2008 All others 62 0 0 0 11 Total 188 0 2 2 32 SME 256 0 2 2 40 2010 All others 93 0 0 0 19 Total 349 0 2 2 57 SME 343 0 2 2 52 End march All others 86 0 0 0 18 2011 Total 429 0 2 2 67 82 2. Composition of the FI’s commercial client base over time—volume of loans(In 100 Million RMB) Type of FI's Standard Year clients Max Min Median Mean Deviation SME 16,853 0 25 955 3,151 2006 All others 14,125 0 7 1,384 3,318 Total 27,071 0 55 2,217 5,947 SME 14,455 1 46 987 2,910 2008 All others 17,792 0 19 1,749 4,087 Total 32,246 1 93 2,546 6,590 SME 28,260 2 113 1,934 5,385 2010 All others 24,965 0 47 2,831 6,322 Total 47,003 2 168 4,530 10,962 SME 28,570 1 132 2,066 5,554 End march All others 25,193 0 29 2,795 6,411 2011 Total 48,470 3 185 4,690 11,340 3. Factors that explain any increases in SME lending between 2005 and the end of March 2011 Number Number of Number of Number of Number of Factors of Very Slightly Not Not Important Important important Important Applicable a. Increasing demand and market opportunities from 32 15 2 1 0 SMEs b. Increasing degree of competition from other FIs 8 23 17 2 0 that are moving into the SME sector c. Passage of the 2007 property Law, including chapter 4 which enabled 9 21 17 3 0 lending on the basis of movable assets d. Chinese regulators have increased incentives for FIs to 15 19 14 2 0 serve SMEs e. Establishment of a new 10 12 19 7 2 central registry for A/R f. The 2009 financial stimulus 7 21 14 8 0 by Chinese authorities 83 4. Top three most important factors that have affected the volume of FIs’ SME lending between 2005 and the end of March 2011 Number of Most Number of second most Number of Third most Factors Important important important a. Increasing demand and market opportunities from 35 6 5 SMEs b. Increasing degree of competition from other FIs 7 18 6 that are moving into the SME sector c. Passage of the 2007 property Law, including chapter 4 which 3 7 8 enabled lending on the basis of movable assets d. Chinese regulators have increased incentives for FIs to 4 16 10 serve SMEs e. Establishment of a new 0 4 9 central registry for A/R f. The 2009 financial stimulus 1 6 11 by chinese authorities 84 C. OVERALL LENDING PORTFOLIO—BY COLLATERAL 1. Composition of the FI’s commercial client base over time—volume of loans (in 100 million RMB) Commercial portfolio in Standard Year Max Min Median Mean Deviation a. Credit loans, unsecured 7,918 0 5 672 1,813 b. Loans secured exclusively by a guarantee(including personal guarantee, group 8,073 0 23 626 1,803 mutual guarantee and guarantee companies) Total 10,465 0 25 704 2,251 ~~Of which, loans secured exclusively by land use rights or 5,640 0 17 257 952 c. Loans buildings 2006 secured exclusively by ~~Of which, loans secured 4,120 0 6 226 754 collateral exclusively by movable assets ~~Of which, loans secured exclusively by both movable and 383 0 2 32 90 immovable assets d. Loans secured by a combination of collateral 1,888 0 10 205 484 and guarantees e. Total 27,071 4 54 2,014 5,954 a. Credit loans, unsecured 12,382 0 7 913 2,356 b. Loans secured exclusively by a guarantee(including personal guarantee, group 7,923 1 43 742 1,747 mutual guarantee and guarantee companies) Total 11,941 0 40 827 2,387 ~~Of which, loans secured exclusively by land use rights or 7,811 0 30 371 1,243 c. Loans buildings 2008 secured exclusively by ~~Of which, loans secured 4,130 0 7 232 714 collateral exclusively by movable assets ~~Of which, loans secured exclusively by both movable and 1,196 0 5 83 264 immovable assets d. Loans secured by a combination of collateral 1,780 0 18 179 385 and guarantees e. Total 32,246 6 134 2,478 6,509 a. Credit loans, unsecured 2010 20,625 0 16 1,510 3,959 85 Commercial portfolio in Standard Year Max Min Median Mean Deviation b. Loans secured exclusively by a guarantee(including personal guarantee, group 11,025 1 64 1,132 2,578 mutual guarantee and guarantee companies) Total 17,091 0 92 1,488 3,887 ~~Of which, loans secured exclusively by land use rights or 11,269 0 41 541 1,740 c. Loans buildings secured exclusively by ~~Of which, loans secured 5,821 0 12 310 957 collateral exclusively by movable assets ~~Of which, loans secured exclusively by both movable and 2,607 0 12 147 538 immovable assets d. Loans secured by a combination of collateral 16,677 0 34 885 3,080 and guarantees e. Total 47,002 7 237 4,466 10,812 a. Credit loans, unsecured 21,157 0 14 1,533 4,050 b. Loans secured exclusively by a guarantee(including personal guarantee, group 11,640 2 67 1,179 2,677 mutual guarantee and guarantee companies) Total 17,818 0 91 1,544 4,065 ~~Of which, loans secured exclusively by land use rights or 11,784 0 43 554 1,810 buildings End of c. Loans March secured 2011 exclusively by ~~Of which, loans secured 6,034 0 9 317 992 collateral exclusively by movable assets ~~Of which, loans secured exclusively by both movable and 2,673 0 12 151 540 immovable assets d. Loans secured by a combination of collateral 16,962 0 47 971 3,187 and guarantees e. Total 48,470 6 242 4,630 11,187 86 2. Composition of your FI’s commercial client base over time—Number of borrowers (in ‘000) Commercial portfolio in Standard Year Max Min Median Mean Deviation a. Credit loans, unsecured 1,195 0 0 33 188 b. Loans secured exclusively by a guarantee(including personal guarantee, group 222 0 2 14 36 mutual guarantee and guarantee companies) Total 3,026 0 2 92 479 ~~Of which, loans secured exclusively by land use rights or 734 0 1 25 118 c. Loans buildings 2006 secured exclusively ~~Of which, loans secured 1,020 0 0 33 177 by collateral exclusively by movable assets ~~Of which, loans secured exclusively by both movable and 3 0 0 0 0 immovable assets d. Loans secured by a combination of collateral and 1,635 0 0 52 289 guarantees e. Total 3,432 0 11 152 609 a. Credit loans, unsecured 70 0 0 5 12 b. Loans secured exclusively by a guarantee(including personal guarantee, group 1,047 0 3 32 155 mutual guarantee and guarantee companies) Total 2,029 0 2 55 302 ~~Of which, loans secured exclusively by land use rights or 1,267 0 1 35 191 c. Loans buildings 2008 secured exclusively ~~Of which, loans secured 742 0 0 19 114 by collateral exclusively by movable assets ~~Of which, loans secured exclusively by both movable and 20 0 0 1 3 immovable assets d. Loans secured by a combination of collateral and 2,606 0 0 76 440 guarantees e. Total 5,682 0 11 154 845 a. Credit loans, unsecured 71,325 0 1 1,529 10,402 b. Loans secured exclusively by a guarantee(including personal guarantee, group mutual guarantee and guarantee companies) 2010 42,811 0 5 947 6,242 87 Commercial portfolio in Standard Year Max Min Median Mean Deviation Total 62,903 0 3 1,429 9,176 ~~Of which, loans secured exclusively by land use rights or 3,028 0 2 75 451 c. Loans buildings secured exclusively ~~Of which, loans secured 354 0 0 10 54 by collateral exclusively by movable assets ~~Of which, loans secured exclusively by both movable and 116 0 0 4 19 immovable assets d. Loans secured by a combination of collateral and 10,280 0 0 357 1,740 guarantees e. Total 188,959 0 14 4,224 27,555 a. Credit loans, unsecured 54,998 0 1 1,158 7,937 b. Loans secured exclusively by a guarantee(including personal guarantee, group 46,054 0 5 999 6,644 mutual guarantee and guarantee companies) Total 65,523 0 3 1,489 9,558 ~~Of which, loans secured exclusively by land use rights or 3,145 0 2 78 468 buildings End of c. Loans March secured 2011 exclusively ~~Of which, loans secured 394 0 0 11 59 by collateral exclusively by movable assets ~~Of which, loans secured exclusively by both movable and 144 0 0 4 24 immovable assets d. Loans secured by a combination of collateral and 11,375 0 0 361 1,870 guarantees e. Total 179,750 0 17 3,939 25,938 88 3. Composition of the FI’s commercial client base over time—volume of loans: FOR SMEs ONLY (In 100 Million RMB) Commercial portfolio in Standard Year Max Min Median Mean Deviation a. Credit loans, unsecured 2,104 0 4 203 522 b. Loans secured exclusively by a guarantee(including personal guarantee, group 4,922 0 16 331 971 mutual guarantee and guarantee companies) Total 8,564 0 9 448 1,589 ~~Of which, loans secured exclusively by land use rights or 4,126 0 9 184 695 c. Loans buildings 2006 secured exclusively by ~~Of which, loans secured 1,493 0 3 89 286 collateral exclusively by movable assets ~~Of which, loans secured exclusively by both movable and 27 0 1 4 7 immovable assets d. Loans secured by a combination of collateral and 666 0 9 74 169 guarantees e. Total 16,853 0 31 949 3,149 a. Credit loans, unsecured 3,346 0 3 197 618 b. Loans secured exclusively by a guarantee(including personal guarantee, group 4,280 0 22 327 864 mutual guarantee and guarantee companies) Total 7,680 0 31 458 1,462 ~~Of which, loans secured exclusively by land use rights or 6,087 0 16 255 960 c. Loans buildings 2008 secured exclusively by ~~Of which, loans secured 1,594 0 5 97 281 collateral exclusively by movable assets ~~Of which, loans secured exclusively by both movable and 43 0 1 7 11 immovable assets d. Loans secured by a combination of collateral and 1,018 0 14 115 241 guarantees e. Total 14,455 1 47 1,006 2,938 a. Credit loans, unsecured 9,419 0 9 486 1,632 b. Loans secured exclusively by a guarantee(including personal guarantee, group 2010 mutual guarantee and guarantee companies) 6,993 0 45 595 1,492 89 Commercial portfolio in Standard Year Max Min Median Mean Deviation Total 12,742 0 47 816 2,396 ~~Of which, loans secured exclusively by land use rights or 9,114 0 27 377 1,399 c. Loans buildings secured exclusively by ~~Of which, loans secured 3,628 0 6 147 568 collateral exclusively by movable assets ~~Of which, loans secured exclusively by both movable and 68 0 4 14 19 immovable assets d. Loans secured by a combination of collateral and 4,798 0 32 361 936 guarantees e. Total 28,260 2 112 2,035 5,454 a. Credit loans, unsecured 9,181 -1 8 463 1,562 b. Loans secured exclusively by a guarantee(including personal guarantee, group 7,449 0 49 610 1,545 mutual guarantee and guarantee companies) Total 13,127 0 49 830 2,460 ~~Of which, loans secured exclusively by land use rights or 9,382 0 29 385 1,434 End buildings c. Loans of secured march ~~Of which, loans secured exclusively by 3,745 0 5 149 581 2011 exclusively by movable assets collateral ~~Of which, loans secured exclusively by both movable and 66 0 10 16 21 immovable assets d. Loans secured by a combination of collateral and 4,875 0 34 396 974 guarantees e. Total 28,570 1 120 2,074 5,552 90 4. Composition of your FI’s commercial client base over time—Number of borrowers : FOR SMEs ONLY (in ‘000) Commercial portfolio in Standard Year Max Min Median Mean Deviation a. Credit loans, unsecured 12 0 0 1 3 b. Loans secured exclusively by a guarantee(including personal guarantee, group 48 0 0 4 10 mutual guarantee and guarantee companies) Total 97 0 0 6 19 ~~Of which, loans secured exclusively by land use 81 0 0 4 14 rights or buildings c. Loans secured 2006 ~~Of which, loans secured exclusively by collateral exclusively by movable 16 0 0 1 3 assets ~~Of which, loans secured exclusively by both movable 1 0 0 0 0 and immovable assets d. Loans secured by a combination of collateral 7 0 0 1 2 and guarantees e. Total 157 0 1 11 33 a. Credit loans, unsecured 15 0 0 1 3 b. Loans secured exclusively by a guarantee(including personal guarantee, group 34 0 1 4 8 mutual guarantee and guarantee companies) Total 105 0 1 6 18 ~~Of which, loans secured exclusively by land use 91 0 0 4 14 rights or buildings c. Loans secured 2008 ~~Of which, loans secured exclusively by collateral exclusively by movable 14 0 0 1 2 assets ~~Of which, loans secured exclusively by both movable 1 0 0 0 0 and immovable assets d. Loans secured by a combination of collateral 9 0 0 1 2 and guarantees e. Total 152 0 2 11 29 a. Credit loans, unsecured 42,128 0 0 1,029 6,579 b. Loans secured exclusively by a 2010 guarantee(including personal guarantee, group 34,547 0 1 741 5,038 mutual guarantee and guarantee companies) c. Loans secured Total 52,260 0 1 1,144 7,704 91 Commercial portfolio in Standard Year Max Min Median Mean Deviation exclusively by collateral ~~Of which, loans secured exclusively by land use 116 0 1 5 18 rights or buildings ~~Of which, loans secured exclusively by movable 30 0 0 1 5 assets ~~Of which, loans secured exclusively by both movable 1 0 0 0 0 and immovable assets d. Loans secured by a combination of collateral 9,815 0 0 275 1,635 and guarantees e. Total 139,983 0 3 2,994 20,416 a. Credit loans, unsecured 32,468 0 0 793 5,070 b. Loans secured exclusively by a guarantee(including personal guarantee, group 37,468 0 1 802 5,464 mutual guarantee and guarantee companies) Total 54,818 0 1 1,202 8,081 ~~Of which, loans secured exclusively by land use 244 0 1 8 37 rights or buildings End of c. Loans secured March ~~Of which, loans secured exclusively by 2011 exclusively by movable 31 0 0 1 5 collateral assets ~~Of which, loans secured exclusively by both movable 1 0 0 0 0 and immovable assets d. Loans secured by a combination of collateral 10,885 0 0 305 1,814 and guarantees e. Total 137,025 0 3 2,934 19,984 92 5. Factors contributing to the FI’s increasing volume of lending on the basis of movable assets Number of Number of Number of Slightly Number of Not Factors Very Important Important Important Important a. Your FI is looking for better ways to serve 26 19 2 0 the SME market segment b. Movables lending enable us to obtain 10 17 17 3 more information and reduce risk c. Passage of the 2007 property Law, including chapter 4 which enabled lending on 16 20 11 0 the basis of movable assets d. Increasing degree of competition from other Fis that are also offering lending based 6 24 14 2 on movable assets e. Risk diversification 12 14 20 1 f. Establishment of a new registry for A/R 13 16 13 1 g. There is increased access to information and technical expertise about movables 3 17 23 4 lending 6. Three most important factors that have affected the amount of lending on the basis of movable assets Number of Number of Second Number of Third Most Factors Most most Important Important Important a. Your FI is looking for better ways to serve 26 10 8 the SME market segment b. Movables lending enable us to obtain more 5 5 10 information and reduce risk c. Passage of the 2007 property Law,including chapter 4 which enabled lending on the basis 9 14 6 of movable assets d. Increasing degree of competition from other Fis that are also offering lending based 2 15 5 on movable assets e. Risk diversification 4 3 6 f. Establishment of a new registry for A/R 2 8 7 g. There is increased access to information and technical expertise about movables 0 1 7 lending 93 7. Types of SME clients for whom the FI’s movable lending products are most relevant Number of Number of Number of Number of Not Industry segments Highly Somewhat Relevant Relevant Relevant Relevant a. Agriculture, forestry and fishing 1 4 17 22 b. Mining and quarrying 1 4 15 21 c. Manufacturing 11 18 16 4 d. Construction 2 2 22 16 e. Wholesale and retail trade 13 13 15 7 f. Transportation and storage 7 11 15 12 g. Information and communication 2 8 13 17 h. Professional, scientific and 2 1 10 26 technical activities i. Rental and leasing activities 1 4 14 20 j. Tourism 0 1 4 31 k. Other services 0 0 2 4 D. SME LENDING PRACTICES 1. Loans in SME lending portfolio for FIs that are secured by different forms of security (100 Million RMB) Approx. amount of outstanding loans(hundred million RMB) from SME clients that use this asset as of December 2006 Number Number Standard Forms of security Max Min Median Mean of Yes of No deviation a. Guarantees (including personal guarantee, group 49 1 4,922 0 16 325 984 mutual guarantee and guarantee companies) b. Land use rights for buildings 47 3 6,000 0 9 343 1,207 c. A/R 36 14 21 0 5 6 7 d. Inventory 29 19 515 0 4 16 30 ~~Within inventory: Agricultural movables 8 42 1,000 0 0 0 0 (e.g., timbers and crops to be harvested and livestock) e. Equipment (including 34 14 1,500 0 1 67 249 vehicles) f. Other (Please write in any additional assets taken as 17 33 80 0 9 214 465 security) 94 Approx. amount of outstanding loans( in hundred million RMB) from SME clients that use this asset as of end of march 2011 Number Number Max Min Median Mean Std deviation Forms of security of Yes of No a. Guarantees (including personal guarantee, group 9,181 0 49 635 1,772 49 1 mutual guarantee and guarantee companies) 9,382 0 23 556 1,718 b. Land use rights for buildings 47 3 121 0 3 17 28 c. A/R 36 14 515 0 1 60 136 d. Inventory 29 19 ~~Within inventory: Agricultural movables 3 0 0 0 1 8 42 (eg.,timbers and crops to be harvested and livestock) e. Equipment (including 1,000 0 4 47 177 34 14 vehicles) f. Other (Please write in any 2,401 0 28 271 618 additional assets taken as 17 33 security) 2. Current lending practices for SME clients Std Loan type Characteristics Max Min Median Mean deviation Average advance rate % 100 0 80 66 38 (average value of loan to security) Loans secured exclusively by a guarantee (including personal, group mutual and Default rate (%) 100 0 1 3 13 guarantee companies) Average recovery 100 0 88 68 38 rate on default (%) Average advance rate % 100 1 66 58 21 (average value of loan to security) Secured exclusively by land use rights or buildings Default rate (%) 100 0 0 3 8 Average recovery 100 0 94 73 39 rate on default (%) 95 E. DETAILED VIEW OF LENDING BASED ON A/R 1. Acceptance of A/R as collateral from SME clients Number of Accepted Number of Not accepted 36 14 a. If A/R is not accepted as collateral, reason for the same Reasons Number of Yes Number of No a. The legal provisions are inadequate 3 12 b. It is difficult or costly to monitor the 11 4 value of the A/R c. The claim on the security is hard to 10 5 enforce in case of default d. The risk of lending on the basis of A/R 13 2 involves greater risk e. This is not in line with our FI's current 4 11 strategic priorities b. If A/R is accepted i. Context a. When did your FI launch any a. When did your FI launch Context small pilot programs for lending official institutional policies against A/R? for lending against A/R? Number before 1995 0 0 Number in 1996 0 0 Number in 1997 0 0 Number in 1998 0 0 Number in 1999 0 0 Number in 2000 0 0 Number in 2001 1 0 Number in 2002 3 3 Number in 2003 2 4 Number in 2004 2 0 Number in 2005 1 2 Number in 2006 1 0 Number in 2007 2 4 Number in 2008 6 6 Number in 2009 7 13 Number in 2010 1 0 Number in 2011 3 1 96 ii. Frequency with which your FIs finance the following types of A/R for SME clients Number of Number of Number of Basis of financing Number of Never Frequently Occasionally Infrequently a. Financing on the basis 11 12 10 2 of a specific receivable b. Financing on the basis 15 6 9 5 of multiple A/Rs c. Financing on the basis of receivables from large 15 10 7 3 companies d. Financing on the basis of receivables from 6 7 14 8 SMEs iii. FI’s experience with lending on the basis of A/R for the most recent reporting period For SME clients that use Max Min Median Mean Std deviation A/R as collateral a. Average advanced rate % 100 3 70 66 100 (Average value of loan to security) b. Default rate (%) 10 0 0 1 10 c. Recovery rate on 100 0 90 66 100 default (%) iv. Monitoring of security by FIs Method Number of Yes Number of No a. Electronic monitoring systems inked to the client's A/R 16 18 management systems b. Clients submit regular reporting on A/R, collections, etc 29 5 c. Loan officers verify a certain percentage or share of 22 12 receivables by contacting the account debtor 97 F. DETAILED VIEW OF LENDING BASED ON INVENTORY 1. Acceptance of inventory as collateral from SME clients Number of Yes Number of No 33 17 a. If inventory is not accepted as collateral, reason for the same Reasons Number of Yes Number of No a. The legal provisions are inadequate 3 17 b. Additional technical expertise would be required to design and launch such a 7 13 practice c. There is no central registry for filing 11 9 inventory as a security d. It is difficult or costly to monitor the 16 4 value of the inventory e. Concerns about the ability to enforce 13 6 the security in case of default f. Concerns about the risks of default 10 9 g. This is not in line with our FI's current 6 14 strategic priorities h. There is insufficient demand from 1 18 clients i. Other reasons 0 19 b. If inventory is accepted as collateral i. Type of inventory the FI will finance Number of Number of Number of Types Number of Never Frequently Occasionally Infrequently a. Standard warehouse 9 9 13 2 receipts b. Nonstandard 9 3 10 11 warehouse receipts c. Pool of current and 15 5 7 6 future inventory 98 ii. FIs’ current practices Characteristics Max Min Median Mean Std deviation a. Average advanced rate % (Average value of loan to 70 1 50 54 14 security) b. Default rate (%) 5 0 0 1 1 c. Recovery rate on default (%) 100 0 100 70 42 iii. Monitoring of security by FIs Process Number of 'Suitable' Number of 'Not Suitable' a. Clients submit regular 26 7 reporting on inventory levels b. Loan officers visit client sites 25 8 at least 4 times per year c. A third party is hired to 31 2 monitor the inventory G. ENFORCEMENT 1. Enforcement of claims : Has the FI ever enforced a claim on movable assets Number of Yes Number of No 21 29 a. If FIs have had to enforce security interest, methods of enforcement Number Number Estimation of time taken to enforce the claim (in months) Methods of Yes of No Max Min Median Std Deviation a. Negotiation 13 8 6 0 3 3 with client b. Court 21 0 30 3 9 9 c. Arbitration 5 16 18 9 12 4 99 H. OVERALL IMPRESSIONS OF SECURED TRANSACTIONS REFORMS 1. Most important effects that the reforms have had on FIs’ ability to serve SMEs Number of Number of Number of Not Number of Not Number of Not Ability to Very Somewhat Very Important At All Applicable Important Important a. Increase access to finance for enterprises of 26 22 2 0 0 all sizes b. The existing SME customers a new loan 18 30 2 0 0 products c. To attract, develop 11 33 4 0 2 new SME customers d. Enable our organization to serve small and medium enterprises previously 20 19 6 0 5 unable to service certain market segments (groups) e. More information on 9 28 9 3 1 SME customers f. Real estate financing by reducing the cost of 11 21 13 2 3 loans to SMEs g. For the SMB customers meet their business needs better 20 26 4 0 0 loan terms (in the loan term, loan amount, etc.) 100 Appendix D: Methodology and Summary Results of SME Survey The SME survey was conducted on 126 enterprises that had access to credit using their A/R as collateral. The objective of the survey was to understand how this project has affected SME businesses on two levels: (1) the SME’s ability to access finance, and (2) the resulting impact on the SME’s business. The survey was administered by China Mainland Marketing Research Co. (CMMR), a local survey firm, via face-to-face interviews. It was conducted across cities with various degrees of SME concentration (number of registered SMEs per capita) and different geographical distribution (two coastal cities of Beijing and Hangzhou and three inland cities of Chengdu, Wuhan and Zhengzhou). The coastal cities have significantly higher GDPs per capita than those of the inland cities.57 Figure 11.1 Cities where the SME survey was conducted Heilongjiang Jilin Xinjiang Liaoning Inner Mongolia Beijing Gansu Tianjin Hebei Ningxia Shanxi Qinghai Shandong Zhengzhou Jiangsu Shaanxi Henan Anhui Shanghai Tibet Sichuan Chengdu Chongqing Hubei Hangzhou WuhanZhejiang Jiangxi Hunan Fujian Guizhou SME Concentration (# of registered SMEs / 1,000 people) Yunnan Guangxi Guangdong >5 1-2 Taiwan 2-5 <1 Hainan The SME samples were drawn from the security interest registry maintained by the Credit Reference Centre (CRC) of the PBOC. For the five cities where the survey was conducted, the survey firm exhausted the list of SMEs available in the CRC registry and attempted to contact each of the listed SME. Nonetheless, 44% of the 3,591 listed SMEs have either moved or closed down, or cannot be contacted by the listed contact number. For the remaining 1,584 listed SMEs, 92% of them cannot be surveyed for various reasons from declining an interview to missing an interview appointment. The resulting low success rate significantly limited the sample data and thereby our ability to draw statistically significant conclusions. There are two potential ways to reduce the refusal rate in future evaluations given similar budget and resources. First, IFC can partner with government units that have the authorities to ‘survey’ SMEs, if such units and authorities exist in the country. Second, if an independent survey firm is used, IFC can invest time to help obtain referrals from credible sources. For example, having bankers of the 57 Source: China Statistical Yearbook 2010 and city statistics 101 SMEs introduce the survey firm will likely boost the acceptance rate of the survey firms’ interview requests. Figure 11.2 Reasons of low success rate for the SME survey 3,591 797 1,210 1,584 1,071 3.5% of total 8.0% of contacted 148 228 126 11 Listed SMEs Enterprise Wrong Refused No suitable Other issues Missed Successfully from CRC moved/non- phone interviews interviewees appointment surveyed Registry existent number The sizes of the 126 surveyed enterprises are determined based on IFC’s proxy definition for SMEs. That is, an enterprise is considered as an SME if its loan size is less than USD 2 million. 80% of the surveyed enterprises are SMEs by this definition. In comparison, 94% of the surveyed enterprises have been recorded as SMEs based on a definition established by Chinese authorities. Figure 11.3 SME Size % Distribution by SMEs Enterprise Size IFC SME Proxy Definition 126 126 Micro Enterprises 6% Loan size < 10,000 USD Large 20% 80% Small Enterprises 44% Loan size < 100,000 USD Medium Enterprises Medium 74% Loan size < 2,000,000 USD 50% Large Enterprises Small Loan size > 2,000,000 USD Micro 6% 1% IFC Definition Enterprise self- Source: IFC brochure: Creating Opportunities for Small Business (2007) reporting Apart from the SME survey of 126 enterprises listed at the CRC registry, the survey firm also conducted a similar survey of 121 enterprises that did not use A/R as collateral. We did not intend to create a control group through this second survey. The objective of this survey was to understand the 102 financing needs of SMEs that did not access A/R financing, and compare them with those that had access to A/R financing. We enhanced the comparability of the two samples by matching the sample of the second survey to that of the first survey in terms of enterprise characteristics such as size, ownership structure, year of incorporation, and business sector. Figure 11.4 SME Sample Stratification % Distribution by Enterprise Size % Distribution by Location for SMEs IFC Loan Size Proxy Definition Enterprise self-identification 126 87 126 121 100 71 100% 1% 1% 100% 100% 6% 10% 7% Micro Hangzhou 24% 8% Small Chengdu 19% Small 50% 59% 35% Wuhan 19% Medium 74% 57% Beijing 21% 28% Medium 44% 31% Zhengzhou 31% Large 20% 17% 21% Large 11% 6% A/R Enterprise Non-A/R A/R Enterprise Non-A/R A/R Enterprise Non-A/R Survey Enterprise Survey Enterprise Survey Enterprise Survey Survey Survey Note: N=87 for the right stack bar as not all enterprises gave their loan sizes % Distribution by % Distribution by % Distribution by Sector Ownership Structure Year of Establishment Collective enterprises 100 71 100 71 100 71 1% 0% 100% 100% 100% State-owned enterprise 7% 3% 1% 10% 3% Service-related 13% Foreign invested 2006 - 2010 19% 13% 6% enterprises 17% Construction and 9% 44% property-related Joint-stock enterprise 28% Manuf acturing 25% 2001 - 2005 46% 80% 32% Private enterprise 75% Wholesale / retail / 53% 56% 1995 - 2000 28% trading 14% <1995 7% 10% A/R Enterprise Non-A/R A/R Enterprise Non-A/R A/R Enterprise Non-A/R Survey Enterprise Survey Enterprise Survey Enterprise Survey Survey Survey 103 SUMMARY RESULTS—SME SURVEY A. ENTERPRISE BACKGROUND 1. Sector of operation Sector Number of Yes Number of No a. Service-related (e.g., travel agency, professional services) 15 111 b. Construction and property-related 11 115 c. Manufacturing 33 93 d. Wholesale / retail / trading 67 59 e. Others 0 126 2. Self-reported size of enterprise Size Number of Yes Number of No a. Small 63 63 b. Medium 55 71 c. Large 8 118 3. Current state of development Development state Number of Yes Number of No a. Start-up 7 119 b. Growth 75 51 c. Mature 36 90 d. Re-structuring 8 118 e. Down-sizing 0 126 4. State of development in 2008 Development state Number of Yes Number of No a. Start-up 29 97 b. Growth 74 52 c. Mature 21 105 d. Re-structuring 2 124 e. Down-sizing 0 126 104 5. Nature of enterprise ownership Enterprise ownership Number of Yes Number of No a. State-owned enterprises 4 122 b. joint-stock company 19 107 c. private 94 32 i. If the business is privately owned, whether a sole proprietorship? (1-Yes/ 2-No) 1- Yes 40 54 2- No 54 40 d. collective enterprises 0 126 State-owned enterprise 0 126 Foreign invested companies 9 117 6. Female ownership in the enterprises Number of Number Answers Max Min Median Mean Standard Deviation Yes of No a. There is female 76 50 NA NA NA NA NA ownership i. If so, how much NA NA 100% 1% 30% 34% 28% equity share holding? b. There is no female 47 79 NA NA NA NA NA ownership c. No individual 3 123 NA NA NA NA NA shareholders B. GENERAL FINANCIAL INFORMATION 1. Current sources of equity and their relative shares Number Number Relative shares Equity sources of Yes of No Standard Max Min Median Mean Deviation a. Personal fund (including retained 114 12 100% 45% 100% 98% 10% earnings) b. Government 2 124 100% 30% 65% 65% 49% investors c. Domestic private investors (e.g., 10 116 100% 10% 49% 56% 40% private equity) d. Foreign investors 8 118 100% 20% 100% 84% 30% e. Others 2 124 100% 0.6% 50% 50% 70% 105 2. Current sources of debt and their relative shares Number Number Relative shares Sources of debt of Yes of No Standard Max Min Median Mean Deviation a. Shareholder loans 24 102 100% 3% 70% 60% 30% b. Banks 115 11 100% 1% 100% 78% 31% c. Non-bank financial 3 123 50% 5% 20% 25% 23% institutions: d. Informal channels (e.g., friends and 18 108 80% 5% 20% 30% 24% family, money lenders) e. Others 23 103 100% 10% 50% 58% 30% 3. Debt-to-equity ratio Standard Max Min Median Mean Deviation What is your enterprise’s debt-to-equity 22 0.02 0.60 1.32 2.55 ratio as of March 2011 Debt : 1,38,980 2.40 1,400 5,747 15,243 RMB/10,000 Equity : 50,000 5.64 2500 5,217 8,557 RMB/10,000 4. Uses of debt Debt uses Number of Yes Number of No a. Purchase of fixed assets 14 112 b. Working capital 123 3 c. Acquisitions 1 125 d. Repayment of previous debt 0 126 e. Others: 0 126 106 5. Year that enterprises first used A/R as security(Year ‘N’) Before 2007 2008 2009 2010 2011 2007 Year that the enterprise first use A/R as a security in a credit arrangement 5 5 28 24 57 7 with any FIs (Year N) 6. Total debt outstanding in the year before first using movable collaterals as security(Year ‘N-1’) Standard Max Min Median Mean Deviation Enterprise’s total debt outstanding during the year before it first started 20,000 100 700 2,435 4,340 using movable collaterals as security (Year N-1) 7. Types of collaterals used as security in that year (Year ‘N-1’) Collateral type Number of Yes Number of No a. Real property NA NA a. Land 10 34 b. Building 26 18 c. Natural resource 0 44 (e.g., mine) b. Movable assets NA NA a. A/R 2 42 b. Inventory 7 37 c. Equipment and vehicle 8 36 d. Intellectual property 0 44 e. Other movable assets: 1 43 c. Guarantees (e.g., guarantee company, personal 8 36 guarantee and group mutual guarantee) d. Others 4 40 107 8. Asset composition in that year (Year ‘N-1’) Number Number Standard Assets Max Min Median Mean of Yes of No Deviation a. Immovable assets (i.e., 29 15 100% 2% 30% 40% 31% real property) b. A/R 36 8 100% 2% 49% 46% 26% c. Inventory 30 14 80% 6% 20% 27% 18% d. Equipment and vehicle 28 16 49% 3% 10% 16% 12% e. Others: 13 31 70% 5% 20% 25% 17% C. A/R FINANCING DETAILS—FIRST CREDIT ARRANGEMENT INVOLVING A/R 1. Size of the first credit arrangement involving A/R (RMB/10,000) Standard Max Min Median Mean Deviation Size of the first credit arrangement involving A/R (can be exclusively or 8,000 5 400 1,021 1,628 partially secured by A/R) RMB 2. Year of the first credit arrangement involving A/R Before 2004 2005 2006 2007 2008 2009 2010 2011 2004 Year that the credit 1 0 1 0 4 26 29 58 7 arrangement was made 3. Advanced rate—Value of credit secured divided by value of A/R used as security Standard Max Min Median Mean Deviation the advanced rate (value of credit secured divided by 100% 5% 70% 66% 28% value of A/R used as security) 108 4. Collaterals used as security besides A/R Collateral types Number of Yes Number of No a. No other collateral 53 73 b. Real Estate 42 84 c. Inventories 11 115 d. equipment and vehicles 13 113 e. a third party guarantee 23 103 f. Other 9 117 a. If ‘Real property’ was used, likelihood of obtaining credit without use of ‘Real property’ as security Number of Yes Number of No a. Very likely 4 38 b. Likely 20 22 c. Unlikely 5 37 d. No 13 29 e. Don’t know 0 42 i. If ‘Yes’ or ‘Likely’, effect on the amount of credit obtained Number of Yes Number of No a. Smaller 13 11 b. Would not be smaller 11 13 5. Possibility of obtaining credit in case of A/R not being allowed as security due to policy or legal restrictions Number of Yes Number of No a. Capable 65 61 i. If you think it will lessen the loan amount? (1 Yes / 2 no / 3 uncertain) 1 Yes 24 41 2 No 19 46 3 uncertain 22 43 b. can not 61 65 109 6. Use of the financing obtained Number of Yes Number of No a. Fixed asset investment 8 118 b. Working capital 122 4 c. Repayment of previous debt 1 125 d. Others 0 126 7. Benefits of financing on enterprises business and employees Number of Yes Number of No a. Grow the business 113 13 b. Grow number of employees 26 100 c. Grow client base 51 75 d. Others 6 120 8. If A/R were given to a bank : Standard Max Min Median Mean Deviation a. How much did the loan cost in terms of percentage (not percentage 50% 0% 10% 15% 12% points) above benchmark interest rate? the duration of the loan? 36 1 12 10 6 9. Methods of acceptance of A/R as a pool (‘bulk’) or piece-by-piece (‘detail’) Number of Yes Number of No Pool 79 47 If pool, were all eligible A/R, rather than only select NA NA pieces, accepted? 1. All eligible A/R 47 32 2. Only some of the A/R accepted 29 50 3. Do not know what eligibility refers to 3 76 Piece-by-piece 47 79 110 10. Types of A/R typically accepted by lenders Number of Yes Number of No a. The Government's A/R department 78 48 b. large domestic enterprises A/R 93 33 c. The bank's existing customer A/R 49 77 d. ordinary customers and qualified A/R 17 109 e. Other 8 118 11. Reasons for non-acceptance of A/R Number of Yes Number of No a. the debtor is not a large enterprise 48 78 b. the debtor is a foreign 29 97 c. part of the debtor's A/R cannot be verified 95 31 d. Other 15 111 D. A/R FINANCING DETAILS—LATEST CREDIT ARRANGEMENT INVOLVING A/Rs (NOT IF IT IS THE SAME ARRANGEMENT AS IN SECTION C) 1. Size of the latest credit arrangement involving A/R (RMB/10,000) Standard Max Min Median Mean Deviation What was the size of the latest credit arrangement involving A/R (can be 54,000 20 520 3793 10,775 exclusively or partially secured by A/R) RMB/10,000 111 2. Year of making the credit arrangement 2010 2011 Year that the credit arrangement was made 12 19 3. Advanced rate—Value of credit secured divided by value of A/R used as security Standard Max Min Median Mean Deviation The advanced rate (value of credit secured 100% 5% 80% 75% 25% divided by value of A/R used as security) 4. Collaterals other than A/R Number of Yes Number of No a. No other collateral 21 10 b. Real Estate 7 24 c. Inventories 1 30 d. equipment and vehicles 2 29 e. a third party guarantee 4 27 f. Other: 1 30 a. If ‘Real property’ was used, likelihood of obtaining credit without use of ‘Real property’ as security Number of Yes Number of No a. Very likely 1 6 b. Likely 4 3 c. Unlikely 1 6 d. No 1 6 e. Don’t know 0 7 i. If ‘Yes’ or ‘Likely’, effect on the amount of credit obtained Number of Yes Number of No a. Smaller 3 2 b. Would not be smaller 2 3 112 5. Possibility of obtaining credit in case of A/R not being allowed as security due to policy or legal restrictions Number of Yes Number of No a. Capable 19 12 i. If you think it will become lessen the loan amount? NA NA (Yes / No / Uncertain) 1 Yes 7 12 2 No 5 14 3 Uncertain 7 12 b. can not 12 19 6. Use of the financing obtained Number of Yes Number of No a. Fixed asset investment 2 29 b. Working capital 30 1 c. Repayment of previous debt 4 27 d. Others: 1 30 7. Benefits of financing on enterprises business and employees Number of Yes Number of No a. Grow the business 30 1 b. Grow number of employees 10 21 c. Grow client base 15 16 d. Others: 1 30 8. If A/R were given to a bank : Standard Max Min Median Mean Deviation a. How much did the loan cost in terms of percentage (not 70% 0% 10% 17% 15% percentage points) above benchmark interest rate? b. What was the duration of 36 1 6 9 7 the loan? (months) 9. Methods of acceptance of A/R as a pool(‘bulk’) or piece-by-piece(‘detail’) Number of Yes Number of No a. volume of A/R 17 14 i. Does each qualified banks to accept A/R are NA NA receivables or only part of being accepted? 1. All eligible A/R 12 5 113 2. Only some of the A/R accepted 5 12 3. Do not know what is qualified 0 17 b. single A/R 13 18 E. OPINIONS 1. In a mature market, using the same collateral to secure loans with more than one FI is permissible under law and accepted. Awareness of this practice in China Number of Yes Number of No a. Aware 26 100 i. If you think this is common behavior? (Yes / No) NA NA 1 Yes 13 13 2 No 13 13 b. Not aware 89 37 ii. If not, whether your company has been trying to use the same amount of A/R loans to the idea of different NA NA institutions or behavior? 1 Yes 6 83 2 No 83 6 c. Do not know 11 115 2. Enterprises with unsuccessful bank loan applications since beginning of 2008 Number of Yes Number of No a. Unsuccessful applications 47 79 b. No unsuccessful applications 79 47 3. Main reasons for unsuccessful bank applications Number of Yes Number of No a. Had ability to pay lenders the loan, but lacked 26 21 acceptable collateral b. the enterprise has a high debt ratio 4 43 a. Could not provide the information/documentation 5 42 required b. Profitability of the business was not satisfactory 4 43 c. Lenders did not have enough capital to lend 8 39 d. Lenders had poor assessment abilities 1 46 e. Lack of credit history 2 45 f. Lenders do not trust private enterprises 13 34 g. Interest rates and fees were too high 11 36 h. The covenants were not acceptable 7 40 i. The business or business owners had history of 1 46 overdue loans j. Others 5 42 114 4. Impact on enterprises’ business in case of not having the latest loan involving A/R Number of Yes Number of No a. Threaten enterprise’s survival 3 123 b. Severely hinder enterprise’s growth 71 55 c. Somewhat hinder enterprise’s growth 34 92 d. Minimal impact 18 108 5. Difficulties in repayment of credit arrangements involving A/R Number of Yes Number of No a. Yes 23 103 i. If there is how you handle this situation NA NA b. No 103 23 F. OPERATIONS INFORMATION—SUPPLEMENTARY 1. Number of employees Standard Max Min Median Mean Deviation Number of employees (end of march 2011) 3,000 5 57 173 389 Number of employees (end of 2010) 2,800 5 48 157 365 Number of employees (end of 2009) 2,200 5 40 130 299 Number of employees (end 2008) 2,200 3 30 116 293 Number of employees (end 2007) 2,200 5 28 108 290 Number of employees (end of 2006) 2,200 3 26 103 288 2. Average annual sales (10,000 RMB) Standard Max Min Median Mean Deviation Annual sales (the end of march 2011) 300,000 400 10,000 23,924 41,138 Annual sales (the end of 2010) 190,000 50 8,000 18,345 30,593 Annual sales (late 2009) 170,000 300 5,500 14,792 26,109 Annual sales (the end of 2008) 145,000 250 4,300 12,831 23,826 Annual sales (the end of 2007) 140,000 100 3,000 10,022 20,828 Annual sales (of 2006) 130,000 80 2,559 9,286 20,169 115 116 Appendix E: Statistical Analysis of SME Survey IFC’s nationwide program and PBOC’s nationwide policies provide no scope for a control group58. To overcome this challenge, we created two samples of SMEs from the survey of 126 enterprises that were intended to be as similar as possible at the aggregate level with the exception that one group had early exposure to A/R financing and the other did not. These samples were matched along nine dimensions. The treatment group (early adopters) ended up with 38 sample SMEs versus the control group's 50 SMEs. We estimated linear regressions using three dependent variables: revenue growth 2009-10, employment growth 2009-10, and revenue growth 2007-09. For independent (explanatory) variables, we used the treatment, SME age, revenue in 2007, and employment in 2007. We did not use the self- reported enterprise size, as the revenue and employment figures are more precise measurements of a firm’s scale. We did not use "city" or "sector,” as either would have required introducing a series of dummy variables so long that the significance of the regression would have suffered further. In none of the estimates was the regression a significantly better fit than randomness at the 90% confidence level of F(5,88). In the estimate of revenue growth 2009-10, the regression was significant at the 87% level, and the coefficient on the treatment (early exposure) was negative and significant at the 89% level. Revenue growth in 2009-10 was lower, on average, in the treatment sample (32% versus 49%). Employee growth saw similar results. This result echoes what we found by simply comparing the averages of revenue growth across the two samples. The tenuous implication of this finding is that early exposure to A/R finance may have been associated with some other (latent) variable that reduced revenue growth, since there may not be a direct negative effect of A/R finance on revenue. In addition, this kind of matching at the aggregate level has several shortcomings. Unlike pairwise matching, the samples are of different sizes, but more importantly, the individual SMEs can actually be extremely different from each other and still match at the aggregate level. Therefore, there may be important differences in unobserved variables. The matching process could also yield different test and control samples if repeated. Given these shortcomings, creating estimates using the matched samples may not be much better than using the complete samples, even though they are clearly idiosyncratic. 58 Source: Handbook on Impact Evaluation - Quantitative Methods and Practices, by Shahidur R. Khandker, Gayatri B. Koolwal and Hussain A. Samad, IFC 2010. 117 Appendix F: Quality of the CRC Registry Data CRC does not conduct substantial review of the registrations and thereby enables FIs to register their security interest and establish claim of priority efficiently and economically. Therefore, the listed data is not verified. Various factors were observed that have potentially led to over-/under-reporting of “total financing value” registered in the CRC registry data. For example, some FIs reported that they entered a new registration each time that client renewed a working line of credit. Also, since the “financing amount” is an optional input field in the CRC registration system, not all registrations include this data. See below a table of potential factors that contribute the data discrepancy. Figure 12.1 Discrepancies in registering financial values in CRC registry Discrepancy Potential Factors Examples from the registry data  Duplicate entries  Repeat registrations  Same revolving loan registered multiple  Revolving loan of USD 1 million for 6 Over-reporting times months is registered  Collateral value is registered in this field  Loan value is USD 1 million but collateral rather than contract value value of USD 1.5 million is registered  Voluntary data field  Registrations do not have a value for contract value Under-reporting  Initial loan size instead of the maximum  Credit line of USD 1 million extended, but contract value is registered only registered used portion of USD 800K  Mistake entering units  USD 1 million entered as USD 100K or USD 1.1 million Over or under- reporting  Mistake converting currency value  USD 1 million entered as USD 1 million instead of converting to RMB 6.5 million 118 Appendix G: Definition of Small- and Medium-sized Enterprises We examined the various definitions of SMEs for this Project. Since SMEs were a major focus for determining the Project’s impact, the difference between various definitions proved to be critical for a constant and insightful analysis of the survey results. The Chinese government definition59 is sector specific and takes into account the annual sales value and the number of employees. According to the IFC definition60, enterprises are classified as micro, small, and medium enterprises (MSMEs) if they meet at least two of three characteristics: number of employees, annual revenues and asset size. IFC also provides a proxy definition based on an enterprise’s loan size. This takes into account only the sizes of the enterprises’ loans while classifying them into MSMEs. The Chinese authorities use higher annual sales for most of the sectors to define MSMEs than does IFC. The Chinese authorities, thus, could consider certain enterprises ‘medium-sized’ while IFC would classify them as ‘large enterprises’. Given that the majority of the data sources had already used the Chinese government definition (CRC, FIs, etc.) this report uses the Chinese government definition. Figure 13.1 Chinese definition of MSMEs Annual turnover Total assets Sector Employee number (million USD) (million USD) Large Medium Small Large Medium Small Large Medium Small Manufacturing >2,000 300-2,000 < 300 >45 5—45 <5 >60 6—60 <6 Construction >3,000 600-3,000 <600 >45 5—45 <5 >60 6—60 <6 Wholesale >200 100-200 <100 >45 5—45 <5 - - - Retail >500 100-500 <100 >25 2—25 <2 - - - Transport >3,000 500-3,000 <500 >45 5—45 <5 - - - Postal >1,000 400-1,000 <400 >45 5—45 <5 - - - Hotel and >800 400-800 <400 >25 5—25 <5 - - - catering Note: Figures have been rounded off Source: State Statistics Bureau of China 59 Source : State Statistics Bureau of China 60 Source : IFC SME Brochure (2007) and IFC SME Banking Guide 2009 119 Figure 13.2 IFC definition for MSMEs Firm size Employees Assets Annual sales Loan size proxies Micro <10