China’s banking regulator throws small business a lifeline

Responding to SMEs' hardship, China's banking regulator has decided to loosen the rules of capital adequacy requirement, loan to deposit ratio and NPL ratio for lending to SMEs. Although this move may not be sufficient to solve the long-standing problem of SME funding, it should help to ease their pain. Thus, it leaves room for Beijing to continue overall credit tightening in the months ahead.We expect another 100bp hike in the reserve ratio and one more 25bp rate hike in the coming months, if not weeks.

Facts:
China Banking Regulatory Commission announced a batch of policy measures to support lending to small enterprises, in a bid to improve lending to small and medium sized enterprises and expand SME loans at a pace faster than the average lending growth.

The main policies include:
- giving priority to receive and review the financial services market access application by small-scale enterprises; banks are encouraged to set up separate branches specializing in providing financial services to SMEs

- giving priority to banks-issued financial bonds that are designated to SMEs lending

- applying a lower risk weighting for loans no more than RMB5mn or US$772,000 when
calculating the capital adequacy ratio

- loans to small enterprises no more than RMB5mn or US$772,000 are excluded from the calculation of the bank's loan to deposit ratio

- applying differentiated standards to non-performing-loan ratios for SMEs and increasing the tolerance level of SMEs' NPL ratios

Implications
CBRC's announcement came in just at the right time to ease lending rules for SMEs. Small enterprises have been facing financing problems for years and their situation only became more challenging with the RRR raised by 400bps and interest rate by 100bps in the current tightening cycle. The actual lending rate to SMEs is normally priced at 30-40% higher than the benchmark lending rate, apart from even higher costs of underground lending. In addition to the financing difficulties, SMEs are burdened by rising labour and raw material costs.

These measures should ease some funding pain borne by the SMEs, though solving the long-standing problem of SME funding requires more structural reforms. It not only provides incentives for banks to lend more to small enterprises, but also keeps the small amount lending from the current stringent regulatory rules. So hopefully it will improve the financing conditions for SMEs, which account for over 80% of employment.

While the relaxation on lending rules to small enterprises serves as a structural adjustment to the lending policy, it also leaves room for Beijing to continue with overall credit tightening in the months ahead. The official targets of around 15% growth in credit and 16% growth in M2 remain unchanged and should be sufficient to support growth of around 9%. The key is to keep tightening until inflationary pressures are meaningfully contained.We expect another 100bp hike in the reserve ratio and one more 25bp rate hike in the coming months, if not weeks.

Bottom line: Easing lending rules to SMEs should help to improve lending to SMEs. It also leaves room for Beijing to continue with overall credit tightening in the months ahead. Our call for another 100bp hike in the reserve ratio and one more 25bp rate hike remains unchanged.