Small and medium-sized enterprises (SMEs) have played an essential leadership role in recent economic development in China to meet various market needs as well as to create sizable number of jobs. However, it has been widely discussed that the financial access of private SMEs is considerably constrained, and improving their financing environment is requisite for sustaining high economic growth and for further promoting the transition to a market economy.
The transaction and information costs to use external financial sources--be it through indirect or direct financing-are generally thought to be higher for SMEs than for large major enterprises. SMEs are generally under disadvantageous position due to the existence of scale economies of financial transactions. The transaction and information costs associated with financial intermediation depend on numerous factors, including the availability and reliability of information concerning a firm's business conditions, relationship between the firm and financial intermediaries, availability of collateral, efficiency and competitiveness of financial intermediaries, and effectiveness of legal and judicial systems to protect financial claims. Against the backdrop of high intermediation costs owing to these underdeveloped institutions, SMEs in developing countries tend to rely on informal financing sources such as family and friends.
Along with these kinds of problems generally observed in developing countries, it should be noted that China, having gradually transitioned to a market economy from a planned one, is still lagging behind in the economically rational allocation of capital. During the period of strong economic growth since the initiation of economic reforms and opening up to the outside, China has succeeded in mobilizing financial resources, and the financial deepening, measured in terms of money supply relative to gross domestic products, has reached an impressive high level comparable to those of advanced countries. However, the capital allocation of China's financial institutions, dominated by the four major state-owned commercial banks, has been seriously distorted for the state-owned sectors, and the financial deepening, as exceptional as it is, has not necessarily contributed to the economic growth (Boyreau-Debray, 2003; Ferri, 2005; Okura, 1996). Thus, in spite of recent dramatic economic development, China still combines aspects of both a developing country and a transitional economy with respect to the capital allocation to SMEs.
Reflecting the interests of policy makers as well as researchers in promoting private SMEs, the number of studies surveying SME financing conditions has grown in China. Lin, Xia, He, and Guan (2003), reporting results of the survey conducted in 2000 on 3,027 SMEs, show that the major financing source of working capital as well as investment capital is self-owned capital for about three-quarters of their sample firms, and suggest that the SMEs have faced significant difficulties in borrowing external funds. ADB (2003), having surveyed the financing sources of private SMEs in Beijing, Shenyang, Xi'an, Wenzhou, and Nanhai, shows that there is a marked difference in the degree of bank loan use among these five cities. The proportion of firms obtaining more than 10 percent of required capital from bank loans are less than 20 percent in Shenyang and Xi'an, but that figure is roughly 40 percent in Wenzhou where the private sector has most developed across the country. Xuan and Okura (2006) also find that the share of private enterprises and individuals in total loans of financial institutions are significantly higher in Zhejiang than in other provinces. These findings suggest that the supply side of private SME financing has more developed in Wenzhou and other cities in Zhejiang Province, seemingly keeping pace with the development of private enterprises. Lin, He, and Cai (2005) report results of a survey on 491 private enterprises in Guangdong Province, and provide valuable information on the relationship between firm size and financing patterns. …