CREDIT CONSTRAINTS ON SMALL AND MEDIUM-SIZED ENTERPRISES: EVIDENCE FROM CHINA

Abstract

Small and medium-sized enterprises (SMEs) have played a crucial role in China's economic development and its market-oriented economic reform. However, further growth of SMEs may be restricted by limited access to formal financing. Using data for 749 Chinese firms from the "China's Investment Climate Survey" conducted in 2003, this paper examines factors that are most important in determining SMEs' access to credit using liner probability model (LPM) and probit models. I find that firm size explains approximately six percentage points in the loan decision-making process (even after controlling for firm characteristics, firm performance, loan characteristics and relation to the government and banks, etc.), and banks extend credit to low-productivity large-sized firms rather than faster-growing SMEs. These findings suggest that the Chinese government should strengthen the nation's legal framework and adopt anti-discrimination policies to reduce transaction costs associated with SMEs in obtaining bank financing. More importantly, the Chinese government should support the development of non-bank financial instruments to better serve the needs of smaller firms and improve competition and efficiency in credit allocation. However, these steps should be taken sequentially and continuously to limit associated risks.