Professor Hua Song of Renmin University of China, Beijing, is the co-author of a recent academic paper entitled Financial service providers and banks’ role in helping SMEs to access finance. Published in the International Journal of Physical Distribution & Logistics Management, it used multiple, in-depth interviews with three different companies in China, three SME suppliers to those companies, and three commercial banks that provide working capital to those SMEs.
Here, Luca Gelsomino, academic director of the Supply Chain Finance Community, asks Prof Song about the key findings of his paper, the state of the market for SME finance in China and the future development of supply chain finance.
Gelsomino: Professor Song, what was the motivation for your paper and what were the key findings?
Song: Starting in 2002, most of the commercial banks in China launched supply chain finance services for companies. But since the financial crisis, more and more companies themselves have been getting directly involved with SCF. In other words, previously, the banks dominated the supply chain finance but since 2008 the sponsor of the SCF has become the companies themselves. So we wanted to explore why companies in the supply chain are directly involved with supply chain finance.
The second point was to compare the different aspects between these two type of SCF [commercial bank-sponsored and company-sponsored].
The third question is about how they control risk. Since 2008 more and more commercial banks have abandoned supply chain finance because they can’t control the ex ante risks and the ex post risks. So this paper just wanted to explore the ways in which the two different parties engaged in SCF control ex ante and ex post risks.
The first thing to note is that the information available [to commercial banks and to focal companies] is quite different is quite different. Why? Because the focal firms are actually involved with supply chain operations, unlike the banks. Even though the banks collect a lot of information such as management information and they investigate the assets of the SMEs, they didn’t directly get involved in organising the business itself. So quite a difference in information exists between these.
Another point we have found is about the network. Because the focal firms directly organise a business network. Companies in a business network have operational structures that create what we call institutional-based trust. Previously when we talked about trust we meant the integrity of the management. But in the supply chain we don’t believe emotional trust – we just believe structured trust. Every SME believes in the network which produces trust, which is based on protecting long-term, reciprocal business.
The third finding is that the focal firms often act as a financial service provider (FSP). And they have plentiful information.
Gelsomino: What is the financial environment like at the moment in terms of the cost and availability of commercial bank finance for SMEs?
Song: The lack of liquidity for SMEs is very serious in China. With the change in circumstances in the global economy, more and more SMEs face a big challenge in working capital. For example, in our paper, I refer to a report by Coface which found that 68% of the Chinese companies surveyed were owed overdue payments and 26.3% of them had an average overdue payment period exceeding 90 days, while for 15.9% of them the average overdue period was greater than 150 days.
But the commercial banks are reluctant to lend money to SMEs because SMEs don’t have a balance sheet. Even if they do have a balance sheet, for many SMEs the figures are, to some extent, not real. So because the commercial banks can’t be sure about the financial data, they are very reluctant to lend money.
The central government has encouraged all the commercial banks to lend money to help SMEs, but the data for last year shows that the average default rate of lending to SMEs is 16% – but today, for some commercial banks it’s even higher than that: for some it’s as high as 30%. So, over the last few years, almost all commercial banks have been getting rid of SME lending.
Without innovative approaches, in my opinion most of the SMEs will go into bankruptcy because they don’t have access to working capital. That’s the background for companies to launch supply chain finance.
Gelsomino: What should companies in China or internationally be learning from this paper?
Song: We have gone through three stages of SCF in China. In the first stage, SCF was dominated by the commercial banks. In the second stage, it is sponsored by focal firms. But in the future, the third stage will see more and more specialised platforms appear to organise and promote cooperation and coordination between every partner [in the supply chain]. This will form the basis to explore opportunities for supply chain finance.
Another point is how to control risk. We looked at ex ante risk [with the three companies we studied]. They have lots of understanding about the structure [of their supply chains] and institutional-based trust – which comes from a long-term, reciprocal transaction relationship. So they can control the ex ante risk and not by seeing the balance sheet.
How to control the ex post is also very important. If you have a very good business ecosystem you can supervise all the behaviour along the whole process. So risk control is not only based on outcomes but also based on process: the behaviour of the SMEs and how they operate. In other words we should spark a very comprehensive, innovative approach to control the overall risk.
Gelsomino: How would you summarise the difference in the SCF market in China and the western world?
Song: The one big difference is that the focal firms have been more directly involved with supply chain finance. In the western world, SCF is sponsored and mainly dominated by the financial institutions, including the commercial banks. Most of the papers and practitioners’ reports say SCF is provided by the banks. But in China, more and more companies directly provide SCF. That’s the main difference. The reasons, as I have mentioned, are because in China it is very hard for commercial banks to get the information they need. Even if they have a lot of credit data, for most SMEs the data is incomplete and even fake. So the commercial banks are reluctant to lend money. But because the companies know the business, they know the strengths of the SMEs, they know the historic transactions, they have more advantages over commercial banks to provide supply chain finance. That’s why more and more companies are directly involved with providing SCF. That’s a very special phenomenon in China.
Over the last year or so a new phenomenon has appeared: the specialised platforms. These specialised platforms help some sectors organise their business and to organise the total production process. But these companies are not directly engaged in production: they just are specialised platforms. They are ecosystem builders. Even in the western world, more SCF is provided by these kinds of platform service provider such as Demica. So in the future, I think this will become a common point between China and the western world.
Another common point between China and the western world nowadays is the emphasise on the value of the data about the transaction. So I think that in China and the western world they are more and more depending on data and new technology to explore the opportunities of supply chain finance.