SME financing taken on by Chinese local governments

China introduces a new category of bonds specifically for SMEs.

China will allow local governments to sell bonds on behalf of small- and medium-sized enterprises (SMEs) to channel more money into this fast-growing sector. The new product, however, will transfer that role to the local governments and away from the financial system.

The introduction of a new class of bonds comes as China ramps up efforts to promote the use of the capital markets to limit the build-up of risk in its banking system. Some Chinese banks have already issued finance bonds this year to fund SME lending.

A well-placed source said that since banks do not have to use their loan quotas for SMEs, the new bonds do not affect their capital adequacy ratios. The bonds will also help remove the default risk from bank balance sheets.

Economists worry that the new bonds may add to an already heavy debt burden of local governments at a time when many of them are struggling to service their bank loans. China’s local governments have amassed debt of US$1.7 trillion or 23% of the 2011 GDP.