The smaller, mostly private firms which drive China’s vast economy are facing increased constraints on a key funding source, as evident in a new data series on credit losses that raises fresh concerns over the broader health of the economy.

Data on acceptance bills – a form of short-term financing that helps funnel liquidity to private enterprises – shows increased strain on finances for small and medium-sized enterprises (SMEs) throughout 2023.

The data, released by the Shanghai Commercial Paper Exchange (SHCPE) since January 2023, reveals widespread failure to pay bills on time, a problem that extends beyond the better-known crisis in the real estate industry.

The slow-moving crisis in China’s property sector is largely responsible for the worsening financial health of its commercial enterprises. A fundamental reason underlying the trend is cash flow issues affecting private enterprises, two banking industry sources confirmed to Enodo Economics.

Reforms in 2022 sought to reduce abuse of acceptance bills that were undermining the financial stability of regional banks. New rules tidied up and increased public disclosure of overdue acceptance bills, allowing fresh insight into how firms are missing payments.

By limiting SMEs' ability to use acceptance bills for cash flow and financing, the reforms could have a broad (and unintended) economic impact.

From January 1, 2024, regulators further limited banks’ ability to extend this financing to SMEs, which provide 80% of urban employment, by restricting the maximum value of acceptance bills. Reforms also reduced the maturation period for new acceptance bills to six months, heightening the pressure on commercial enterprises to pay within a shorter time frame and tightening cash flow.

The concern is that these reforms will undermine the one form of bank credit predominantly supporting SME liquidity, with the government yet to address the underlying reasons for the shortage of  capital flowing to the private sector. 

In line with the new limits on the maximum value of acceptance bills, Enodo expects SME access to funds and overall liquidity to decrease further in 2024.

This is not the only hidden cost of the new measures. As banks must re-classify overdue acceptance bills as NPLs, they have instead begun hiding the scale of their acceptance bill losses. Banking industry sources told Enodo some banks have avoided reclassification by issuing new loans in place of overdue bills where they have failed to recover the losses within a certain timeframe and after redeeming the collateral.

It is difficult to ascertain how widespread this practice is. But its existence indicates the extent of actual overdue acceptance bill payments may be higher than the SHCPE data shows, and that some new loan growth is in fact a smokescreen for existing bad loans. We will explore what the SHCPE data can tell us about banks in a separate Enodo Insight.

Credit by any other name

Chinese banks have long resisted lending to private enterprises, believing that it is far riskier than lending to state-owned enterprises. One of the few channels that does provide liquidity to private enterprises is the acceptance bill.

When a company makes a sale, it can agree to either receive cash immediately, or arrange to accept payment at a later date, raising the risk that the buyer will default or that the seller will run out of cash before payments arrive. Bankers’ acceptance bills, issued by the bank for a small fee, guarantee payment at an agreed later date, thus absorbing some of the risk to the seller.

Acceptance bills are also transferable, allowing the company that has made the sale to pass it on to another company instead of cash. Holders of the bill can exchange the acceptance bills for cash at a bank prior to maturity. Banks buy a bill at a discounted rate, or less than it is worth at maturity.

This means that in China, bankers’ acceptance bills are effectively interbank loans – one of the safest forms of credit. With commission fees and interest income higher than for normal loans, banks are more willing to issue them to private enterprises. They have thereby become one of the most effective channels of liquidity to the non-state sector.

Issuance of acceptance bills began to increase in early 2018, when the central bank declared them one of its ‘three arrows’ for dealing with small firms’ insufficient access to credit. Issuance had doubled by 2022 as banks rushed to use acceptance bills to meet government-imposed quotas for annual lending.

But the increase in issuance masked a more insidious trend – regional banks arbitraging acceptance bills to inflate deposits and hide their liquidity issues. The most prominent culprit was Baoshang Bank, which had Rmb200bn of outstanding loans before its 2020 collapse, but nearly Rmb300bn of transactions with over 700 partners on the interbank market.

Baoshang was not alone – Caixin reported in 2022 that some lenders in northeast China had generated 60% of their deposits this way.

In response to spreading risk, regulators tightened up. 

Stricter measures that took effect on January 1, 2023, required bills to be based on ‘real transaction relationships,’ reduced payment periods to six months from a year and required banks to classify overdue acceptance bills as non-performing loans.

Two more measures – capping the maximum value of an acceptance bill at 15% of the payer’s total assets, and capping the margin deposit for acceptance bills at 10% of the payer’s deposits at the issuing bank, came into effect in January of this year. Other new rules expanded required disclosure.

A snapshot of delinquent firms

A requirement to list repeat offenders provides a fascinating snapshot into the details of individual companies that are struggling in China’s slowing economy. Not surprisingly, many of these are real estate firms. Others are in the secondary industries serving China’s construction boom – forestry products, for instance.

The SHCPE maintains two lists of enterprises with overdue acceptance bills. The first list, which existed prior to the rules with different criteria, includes enterprises with three overdue acceptance bills within the last six months. A new list of ‘continuously overdue’ enterprises includes enterprises that have appeared on the former list three times in the last six months.

The ‘consistently overdue’ list shows a worrying increase in enterprises missing payments in the latter half of 2023, Enodo Economics has found.

The number of enterprises on the list reached 3,408 in December, just over 4% of enterprises registered on the platform. In March, the first month the list was available, only 1,249 enterprises appeared. 

The SHCPE does not disclose the total value of the overdue acceptance bills represented on either list, but does allow users to search for the value of each individual enterprise’s bills.

In December, for example, the top 10 enterprises reported a total of Rmb27.1bn in total missed acceptance bill payments, with Rmb17.5bn still outstanding at the end of the month. The lists showed that 227 enterprises had missed acceptance bill payments worth over Rmb100m each.

The number of new enterprises appearing on the overdue list also rose in the second half of the year. In part, this may reflect traditional payment practices among private firms, which tend to settle their debts at the beginning of the calendar year, once fresh loans become available.

However, construction industry sources confirmed to Enodo Economics that companies did indeed face severe liquidity issues in the second half of 2023. One estimated that around 80% of developers and suppliers are currently in arrears, with over 50% of these arrears in the form of acceptance bills. Other sources agreed this assessment was accurate. The data therefore likely understates the scale of overall losses.

The value of the unpaid acceptance bills reported for new entrants is considerable. In December, Fujian Yanjing Supply Chain Management had the largest amount of unpaid acceptance bills among the new entrants, at Rmb757m. As of the end of the month, it had not paid any of the acceptance bills it owed.

Conclusion

In attempting to solve an issue undermining the banking sector, regulators have increased pressure on the SME sector. Reforms intended to prevent the acceptance bill arbitrage from inflating bank assets may further limit private access to the funding necessary for survival.

Increased non-payment of acceptance bills is a symptom of the liquidity issues facing commercial enterprises. This will weigh on the economy in 2024, unless and until banks and regulators manage to get capital to flow to the most productive sectors of the economy.

China’s industrious SMEs have endured several difficult years, exacerbated by the crisis in the property sector and Covid-related disruptions. SME health is a crucial indicator for the economy overall, but the financial squeeze revealed by the SHCPE data heralds further woes to come.

In the next Enodo Insight, we will take a look at what the new data can tell us about risks to regional bank liquidity.