IFC Secured Transactions Advisory Project in China 1 Background In 2004, the People’s Bank of China (PBOC) recognized an appropriate legal and institutional framework to allow wide spread financing difficulties among small and and facilitate the use of movable assets such as receivables medium enterprises (SMEs) and requested technical as collateral for loans. This was particularly important for support from IFC in the modernization of China’s Secured China’s large number of SMEs, whose assets were mostly Transactions system. The main objective of IFC’s Secured in the form of equipment, inventory and receivables and Transactions Advisory Project in China was to increase who reported access to credit as their most significant access to credit to firms, especially SMEs, by developing business constraint (see Figure 1). Figure 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 71% financing Intense competition 71% Heavy tax burden 34% No preferential policy (implying lack of 33% connections) Source: NDRC/PEP-China 2005/2006 SME Finance Survey (1,000 SMEs in Five Cities) Secured Transactions in China Before the Reform l One key factor contributing to the SME financing of an adequate secured transactions law and the poorly difficulties was the severe restriction on the use of functioning registries. movable collateral under China’s secured financing l Lenders did not want to take movable assets as laws. collateral because of an unfavorable legal framework l Chinese banks were reluctant to provide credit to a and a lack of knowledge and experience in dealing majority of SMEs which had no or little real estate with movables. collateral. As a result, Chinese businesses hold more l The China secured transactions law lacked all the than 2 trillion USD in “dead capital” (their movable essential elements required to support the efficient and assets). effective utilization of the secured lending market. It l Assets owned by private firms, SMEs and farmers was not possible either to create security interest over could not be used as collateral to generate loans to revolving assets and future assets. Security interests on fund business investment and growth due to the lack some assets such as receivables had no registry to be publicized. 2 Results Achievements The Project has successfully fulfilled its objective of incorporates all the key features of a modern movable establishing a solid secured transactions system that has collateral registry (such as accessible on-line to the users resulted in a sustainable flow of additional credit to the and public, user accounts, notice based registry in which SME sector. The main project achievements include: information limited to the creditor, debtor, loan amount and the description of assets, centralized information, The 2007 Property Law reasonable fees). The new Property Law in China was enacted in 2007. It adopted a number of important principles of modern Public awareness and education—Building secured transactions system and it opened up the scope industry capacity for movables lending (including receivables), set up Training and capacity building were key elements for a clearer priority rule, and provided a better basis for the project’s success. The project targeted both client enforcement. and public sector stakeholders to create awareness about the new system; and private sector stakeholders (such Thanks to the contribution of this project and the efforts as Financial Institutions, NBFIs, firms, lawyers) mostly of China´s stakeholders to reform its secured transactions focused on creating awareness and building bank’ system and bankruptcy framework, in Doing Business 2012, expertise on movable assets based financing products. China gained 6 points out of an 8 point scale on the News articles and advertisements about receivables financing are now common in China and at least 62 “legal rights” index of the “getting credit indicator”, training events have been delivered by the project since which measures the quality of lenders and borrowers rights. early 2004. Security Interest Registry A modern security interest registry for account receivables was created in October 2007 and for leasing in 2009. The registry is managed by the Credit Reference Center, which is a public service unit under PBOC. It is China’s first nation/wide, central and internet-based filing system for secured transactions. The new receivables registry 2 IFC Secured Transactions Advisory Project in China Impact Dalberg, an international development consulting firm, l China’s Big five banks (Industrial and Commercial conducted an independent evaluation of this project to Bank of China, Agricultural Bank of China, Bank validate the results and gather additional information of China, China Construction Bank and Bank of about the impact on different levels (financial sector, Communications) posted strong gains in the share of financial institutions and businesses/SMEs). The report financing that is secured by movable assets. was delivered to IFC in November 2011. The main l The Credit Reference Center recorded cumulative impact findings of this evaluation are1: accounts receivable financing of about USD $3.5 trillion since Oct. 2007, representing around 385,000 On the Chinese financial sector: registrations (see Figure 3). l Total number of commercial loans involving movable assets grew by 21 percent per year in 2008-2010 versus a flat rate in 2006-2008 (see Figure 2). Figure 2 Growth of commercial loan portfolio secured by 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% 15% CAGR 2006 2008 2010 2006 2008 2010 Source: 32 financial institutions surveyed in Anhui, Guangdong, Shaanxi, Shandong, Shanghai, Zhejiang, including three Big five banks, four large policy and commercial banks and 25 local banks. Note: Include loans secured exclusively by movables as well as those secured by a combination of movables and immovables Figure 3 Growth in the number of registrations of Accounts Receivables transactions Total number of registrations Cumulative number of registrations and searches (Accounts Receivables and factoring) (2007Q4-2011Q2) 96,444 384,429 500,000 450,000 Searches 159,718 400,000 Registrations 350,000 300,000 250,000 85,020 200,000 150,000 100,000 33,802 50,000 9,445 0 2007 Q4 2008 2009 2010 2011 Total 2007 2008 2009 2010 2011 2012 Q1-Q2 Source: Credit Reference Center Movables Security Interest Registry 1. The evaluation is based on extensive desk research, an in-country mission to interview key stakeholders, surveys of 247 SMEs and 50 financial institutions, data from Credit Reference Center (CRC) Registry, and case studies of SMEs and financial institutions. IFC Secured Transactions Advisory Project in China 3 On SME lending by financial institutions: l 87 percent of surveyed financial institutions rated the 2007 Property Law as very/somewhat important to l The 2007 Property Law and the accounts receivable “serve new segments of SME market” (see Figure 5). Registry were among key drivers of the adoption of lending secured by movable collateral (see Figure 4). l Financial products were created based on movable assets. Financial News independently reported 36 l Important spillover effects into other types of financing cases of new financial products based on movable such as leasing and factoring. The lease registry has assets in 2010 and PBOC published 120 cases in a recorded 35,426 leasing transactions cumulatively. book in 2010. 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. On SMEs: l Overall default rates for loans secured by movable As of June 30, 2011, cumulatively this project has assets remain low. The mean default rate for Accounts facilitated USD $3.58 trillion accounts receivable Receivables lending is 0.45 percent and for inventory financing including USD $1.09 trillion of SME lending is 0.6 percent. in China, as indicated by the Registry´s data. l Four of the Big five banks reported an average l SMEs perceive “unacceptable collateral” as by far the 25 percent compound annual growth rate (CAGR) #1 reason for why their loan applications were denied of their movables lending in 2008-2010, up from in the past. 59 percent of surveyed SMEs believe 2 percent in 2006-2008; seven other large commercial that their business development would be severely banks reported an average of 45 percent over impacted, or worse, if their current access to movables 20 percent. financing were to be removed. 88 percent of surveyed Figure 4 Reasons for the increased lending secured by movable collateral among surveyed financial institutions FIs looking for better 55% 40% 4% ways to serve SMEs 0% Passage of 2007 34% 43% 23% 0% Property Law Establishment of new A/R registry 30% 37% 30% 2% Increasing degree of competition from 13% 52% 30% 4% other FIs Enables FIs to obtain more information 21% 36% 36% 6% and reduce risk Risk diversification 26% 30% 43% 2% Increased access to information about 6% 36% 49% 9% movables lending n = 47 Very Important Important Slightly Important Not Important 100% Source: 50 financial institutions (Fls) surveyed in Anhui, Guangdong, Shanxi, Shandong, Shanghai, Zhejiang 4 IFC Secured Transactions Advisory Project in China Figure 5 Perceived impact of IFC project outcomes Overall impact of 2007 Property Law on FI lending behavior Perceived impact of 2007 legal and registry reform and movable financing awareness promotion on financial institutions 100% Increase access to finance for enterprises of all sizes 52% 44% 4% 0% Serve new segments of SME market 44% 42% 13% 0% Offer SME customers more appropriate loan terms 40% 52% 8% 0% Enable the offering of new products for SME customers 36% 60% 4% 0% Attract, develop new SME customers 23% 69% 8% 0% Reduce borrowing costs of SME customers 23% 45% 28% 4% Gain more information about SME customers 18% 57% 18% 6% n = 50 Very Important Somewhat Important Not Very Important Not At All Source: 50 financial institutions surveyed in Anhui, Guangdong, Shanxi, Shandong, Shanghai, Zhejiang, Beijing SMEs said that business growth was a benefit resulting l 68,575 SME borrowers (excludes unincorporated from obtaining accounts receivables financing borrowers) were extended loans secured by accounts (see Figure 6). receivables which represent 62 percent of the transactions (Note: this is not the total number of l 63 percent of SMEs that obtained new loans using borrowers; only incorporated legal persons). accounts receivable had female ownership while 20 percent are majority owned by women (see Figure 7). Figure 6 Benefits of Accounts Receivables financing Figure 7 Benefits of Accounts Receivables financing % share of Benefits of financing obtained for SMEs business ownership 63% SMEs have female ownership 100% Growth in business 88 90% 80% 70% Growth in client base 43 60% 50% Growth in employees 21 40% 30% 20% Others 6 10% 0% n = 100 Female Male # of SMEs Source: 100 SMEs surveyed in Beijing, Chengdu, Hangzhou, Wuhan and Zhengzhou Source: 124 SMEs surveyed in Beijing, Chengdu, Ha IFC Secured Transactions Advisory Project in China 5 3 Lessons learned Four Replicable Lessons Were Identified l Partner with a politically powerful agency with Merge local knowledge with global subject- l market knowledge and administrative capacity. matter expertise. Consistent management support People´s Bank of China has been a strong local of a tripartite team of IFC global and local members, champion for reform efforts and its understanding of and government (PBOC) members has contributed the credit market facilitated the use of international to effective management and dissemination of best practices for the design of the reform and registry. knowledge. Asset-based lending is becoming a credible Its nationwide network of regional branches has been lending mechanism in the way that financial statement instrumental in facilitating effective outreach and lending already is. SMEs, in addition to large and awareness among financial institutions throughout state-owned enterprises, have become target clients of the country. commercial lending, by virtue of their movable assets. l Position the reform as the “creation of a market”. Sustain a long-term effort with a professional l The complementary activities to promote the team over time. The impact of building or reforming movables financing sector were essential to the a country´s financial infrastructure takes years to Project’s success. Successful market development and materialize. The program manager has been involved reform requires efforts on multiple fronts including in the reform process since 2003. The Project team´s administrative reform, judicial reform, and capacity ability to build a working relationship with a diverse building of the industry. Even though the Property range of stakeholders has been critical to the effective Law is not completely aligned with global best implementation of the Project. practices the movable lending industry has been able to grow substantially. 4 Remaining challenges Improve the legal and regulatory framework l Reach out to the SME sector through an l of movables financing through judicial educational campaign to boost the business interpretations. Some of the regulations associated community’s awareness of the benefits of movables with movables financing such as priority rights in financing. There are still opportunities to promote more complex situations and procedures for claims adoption of movables financing by smaller financial enforcement require further clarification. institutions through further awareness raising and Lower the costs of establishing priority over l technical assistance. Many SMEs are also unaware security interest in equipment and inventories by of the possibility of using Accounts Receivables and building a national registry. There are opportunities movables collaterals. to build on the success of the Accounts Receivables To promote movables financing for rural and small l Registry by improving the existing registry and borrowers by small lenders. potentially building up a national electronic registry for equipment and inventories. Increase financial institutions’ capacity by adopting l and innovating lending technologies. There is room for further strengthening of the service sector that supports movables financing such as third party firms that specialize in evaluating and monitoring assets, and related “market infrastructure” building that would reduce the transaction costs associated with movables lending. 6 IFC Secured Transactions Advisory Project in China Case 1: Construction Company in Zhejiang Benefits brought by access to movables financing: l Growth in operations: from RMB 100 million (approximately USD $12.8 million) in sales in 2006 to RMB 900 million (approximately USD $134.8 million) in 2010 and hired 400 more employees in the same period. It has been able to increase its movables-backed borrowing three to four times since 2007. l Increased plant efficiency: three party agreement (company, bank and collateral management firm) shortened production cycle by three to five days. This led to reduced inventory days and increased working capital without any increase in inventory storage capacity. Case 2: A Large Financial Institution Introducing Movables Lending Nationwide Impact of adopting movables financing on lending activities: l Diversify business portfolios and build up a more reliable Share of the Lending Volume of Commercial stream of revenues. Loan Portfolio Secured by Movable Assets l Movables financing now plays a critical role in the financial 36% institution’s growth and product offering. Implications for SME lending: 16% 13% l Expansion into serving SMEs in the manufacturing, trade, and construction sectors. 2006 2008 2011 l Risk associated with movables financing is lower than the Source: 2011 IFC financial institution Survey real property-based financing. l Movables financing enables the financial institution to have greater access to the borrower’s businesss performance information, and is much more insightful for predicting the chance of loan default than the value of property. l The financial institution significantly increased both the number of SME clients and the total lending volumes to SMEs. Figure 8.1 Changes in SME lending activity Figure 8.2 Changes in SME lending volume Commercial loan portfolio Commercial loan portfolio Commercial loan portfolio Commercial loan portfolio Number of SME clients as a % of total Indexed Growth in the Number of Volume of lending to SME clients as a Indexed Growth in the Number of active clients SME clients % of total portfolio SME clients 60 260 Value in 2006 = 100 Value in 2006 = 100 91 160 83 87 44 45 108 100 130 100 2006 2008 2010 2006 2007 2008 2009 2010 2006 2008 2010 2006 2007 2008 2009 2010 Source: 2011 IFC financial institution Survey Source: 2011 IFC financial institution Survey IFC Secured Transactions Advisory Project in China 7 Contact: Alejandro Alvarez de la Campa Global Product Leader – Secured Transactions E-mail: aalvarez1@ifc.org Phone: +1 202-458-0075 Web: www.ifc.org APRIL 2012