Informal Finance in China - Literature review Example

?Business Literature Review Table of Contents Business Literature Review Table of Contents 2 Literature Review I – Informal Finance in China 3 Introduction 4 Research and Analysis 4 Conclusion 7 Literature Review II –B2B relationships in China 8 Introduction 9 Research and Analysis 9 Conclusion 12 Reference List 13 Literature Review I – Informal Finance in China Introduction Informal financing refers to financial sources that do not belong to the organised banking and financial sector of the economy. In China, there are many types of informal financers such as, Rotating Savings and Credit Associations (lending cooperatives formed by members of the society) like, bahui, hehui and yaohui, private lending individuals, lending enterprises and pawn brokers, who extend credit in exchange of non-traditional collaterals such as, jewellery and personal belongings. The Chinese government has legalised informal financing with the conditions that the money must not be raised from the general public and the maximum rate of interest must not exceed quadruple of the interest charged by formal institutions. Since ROSCAs typically fix the interest through bidding among the potential loan receivers, they exceed the interest limit of the government and are thus considered illegal and operate under cover (Chen, 2003; OECD Publishing, 2005; Li and Hsu, 2009). Informal lending institutions are officially allowed to charge much higher than formal lending institutions, which is why the cost of borrowing from such sources becomes very expensive. Judging by their resources and capabilities, this puts additional financial burden on private businesses. However, most of the loan applications by private businesses to banks and financial institutions get rejected primarily on grounds of absence of a previous credit history, sufficient collaterals and guarantee of repayment. Thus, whereas formal lending institutions shy away from granting loans to private businesses, the credit crunch created due to non-availability of finance is being increasingly tended to by informal lenders. The article tries to get an insight into the financial system of China and analyses the dynamics of formal and informal financial institutions (Tanaka and Molnar, 2008). Research and Analysis The literature primarily wants to estimate the sizes of formal and informal lending markets, the criteria based on which loans are granted in each of these markets and the propensity of private businesses to borrow from the formal and informal lending institutions. To fulfil its objectives, the authors Kensuke Tanaka and Margit Molnar primarily use data from modified copy of a 2002 survey, conducted on 2500 private enterprises in China by the State Administration for Industry and Commerce, modified by Chinese University of Hong Kong in 2004 (Chinese University of Hong Kong, 2004). Using the data, the authors have drawn a perspective of the finance industry of China as given below: Business size by sales (million ?) upto 1 1 to 3 3 to 10 10 to 20 20 to 50 more than 50 Businesses with borrowed funds 46% 57% 61% 64% 71% 58% Borrowings from formal lenders 14% 23% 28% 35% 44% 36% Borrowings from informal lenders 20% 18% 15% 12% 10% 8% Informal borrowings in products sector 23% 24% 20% 26% 9% 4% Informal borrowings in services sector 44% 35% 9% 12% 12% 9% The authors find that informal lenders are a significant source of finance for small private businesses, since formal lenders find them the riskiest due to unavailability of past credit history. Moreover, borrowing from informal lenders is more rampant in services sector than the products sector, chiefly because they have less tangible goods to keep as collateral. The authors compare the calculations with the findings of a survey conducted by Central Finance University that stated that the least developed areas of China (which coincidentally host the smallest private businesses) have the highest share of credit from informal lenders (Central Finance University of China, 2005). Next, the authors try to understand the factors which influence the decision of formal lenders to extend credit to private businesses. For this, the authors use Probit analysis on the data from SAIC survey and summarise results as below:   Coefficient value (10-1) Entire China West East Northeast Central Credit History 9.09 9.05 9.86 8.39 7.77 Manufacturing Activity 2.74 0.71 3.81 6.06 -0.36 Size of Company 1.89 2.34 1.22 3.09 3.02 Profitability 1.83 2.82 1.77 2.71 -3.31 Credit Rating 0.05 0.11 0.06 0.02 0.03 The findings indicate that overall, formal lenders emphasise most on the credit history, followed by the presence of manufacturing activity and size of the company and profitability of the business and credit rating has lesser importance. This explains the formal lender’s tendencies of overlooking growth prospects of private businesses and extending majority of the credit to products sector, since they can produce collaterals. However, western and central parts do not put much importance to collaterals, whereas eastern and central parts do not emphasise on profitability. The authors conclude that the evaluation criteria of formal lenders vary between coastal and interior regions. Lastly, the authors try to understand the factors determining the size of credit extended by formal and informal lenders and collate their results as below:       Coefficient value (10-1) Entire China Eastern regions Coastal areas Formal Informal Formal Informal Formal Informal Corporate Taxes 89.39 -5.31 97.36 -5.01 146.71 -4.19 Credit Rating 0.14 -0.004 0.21 -0.005 0.01 -0.019 Size of Company 11.32 -2.13 11.37 -3.13 15.2 -2.55 Prior Formal Borrowings 32.21 2.63 39.76 3.67 33.47 1.73 Years of Operation -0.36 -0.32 -0.09 -0.49 -0.25 -0.19 Manufacturing Activity 9.97 2.37 18.06 4.88 16.61 3.5 Bills Receivable 0.63 3.33 1.08 3.5 1.24 0.74 Bills Payable -6.59 -0.2 -9.46 -1.76 -41.17 -12.69 The authors summarise that the most important factors that formal lenders rely on are the amount of corporate taxes paid, which reflects integrity and stability of a business and also, manufacturing capabilities. Also, greater loan amounts are extended to larger businesses that can show higher credit ratings. On the other hand, informal lenders are more inclined to extend credit to small and young private businesses with large amounts of bills receivable, decent manufacturing activities and prior credit history with formal lenders. Conclusion The findings of the literature indicate that formal and informal lenders consider sets of very different determinants while granting credit to businesses. Formal lenders emphasise on historical records of a company such as, corporate taxes and past credit history, along with stability of the company’s operations. Contrarily, informal lenders emphasise on present trends of a company such as, the value of bills receivable. As an additional hedging, they also look towards prior credit history with formal lenders, which may help to lower risks and bad debt. Literature Review II –B2B relationships in China Introduction For any business-to-business transaction, there are a few key elements that can make or break deals. These are the degree of dependability of the buying manager on the salesman, the professional and personal relationship enjoyed between them and the skills, knowledge and credentials of the salesman. Some like, Katz and Kahn, believe that inter-organisational relationships are purely professional, that do not vary from person to person, but are codified and standardised by companies (Katz and Kahn, 1978). Whereas, others like, Weitz and Jap, believe that interpersonal relationships have historically affected inter-organisational relationships and continues to do so (Weitz and Jap, 1995). In this article, the authors, Don Lee and Philip Dawes, focus on China and try to understand how interpersonal relationships (called guanxi in China), dependence of buying managers on salesmen and long-term business partnerships interact with each other in the Chinese business-to-business environment (Lee and Dawes, 2005). Research and Analysis To understand the dynamics of guanxi, dependence and long-term partnerships, the authors surveyed about 130 companies who source components from the same supplier. They questioned regarding public images of buying and selling personnel, commitment of salesman to the buyer-seller friendship, willingness of salesman and buying manager to return each other favours, salesman’s skills and respectable position in the business environment, professional and personal interactions between salesman and buying manager, degree of buying manager’s dependence and reliance on salesman and selling company and orientation of the managers to form a long-term partnership with the seller. Through PLS regression, they assigned scores to each question, a part of which is demonstrated below: Category Item Score (10-1) Average variance (10-1) Image in society It is important for both managers and salesmen 8.6 8.1 It grows with increasing respect 9 It is something both managers and salesmen each other 9.4 Commitment to friendship Salesmen often gift tangible gifts to managers 6.9 7.2 Salesmen wish managers on anniversaries and events with cards 9.2 Salesmen and managers are genuine friends 9.4 Salesmen and managers are fond of each other 8.1 Returning favour with favour If salesmen did favours to managers, they would return the favour 9.1 8.5 If managers did favours to salesmen, they would return the favour 9.3 Salesman’s skills Has sufficient skills and knowledge in his domain 9.7 8.6 Has sufficient knowledge of the market environment 9.3 Can recognise buyer's problems and solve them effectively 8.8 Can offer alternate ways of expanding business with current resources 9.2 Salesman’s position Has contacts with multinational suppliers 8.2 7.5 Has contacts with the best local suppliers 8.7 Commands high respect in his/her own company 9.1 Is highly educated 8.5 The authors noted that average variance of all categories were greater than 5x10-1, which indicates that the evaluation model is valid under the stipulations of Claes Fornell and David Larcker (Fornell and Larcker, 1981). Next, the authors conducted a Varimax rotation analysis on the three components of guanxi, image, favour-returning and commitment, as below: Category Item Varimax scores (10-1) Image in society Commitment to friendship Returning favour with favour Image in society It is important for both managers and salesmen 8.7 - - It grows with increasing respect 8.5 It is something both managers and salesmen each other 8.1 Salesmen often gift tangible gifts to managers - 9.2 Commitment to friendship Salesmen wish managers on anniversaries and events with cards 8.4 Salesmen and managers are genuine friends 7.7 Salesmen and managers are fond of each other 7 Returning favour with favour If salesmen did favours to managers, they would return the favour - 8.9 If managers did favours to salesmen, they would return the favour 7.7 All Varimax scores were greater than or equal to 7x10-1, indicating that all questions bear significance. Lastly, through factor analysis, they calculated the significance of image, commitment and favour-returning on guanxi as below: Category Score on Guanxi (10-1) Image in society 8 Returning favour with favour 8 Commitment to friendship 8.5 The authors noted that all three have scores of 8x10-1 or higher, thereby proving that they are strongly related to guanxi. Next, they analysed the interaction between the various categories considered in the survey and summarised scores as below: Scores (10-1) Image in society Returning favour with favour Commitment to friendship Salesman’s skills Salesman’s position Professional Interaction Personal Interaction Reliance on salesman Reliance on salesman’s company Long-term partnership Image in society 9                   Returning favour with favour 5 9.2                 Commitment to friendship 4.3 5.4 8.5               Salesman’s skills 3.5 1.6 2.4 9.3             Salesman’s position 3.7 3.4 1.2 6.8 8.7           Professional Interaction 2 2.4 -0.3 4.8 8.1 9.4         Personal Interaction 2.9 3.5 2.1 6.4 7.4 7 9.5       Reliance on salesman 1.5 -0.6 3 5.8 4.6 3.9 4.2 8.6     Reliance on salesman’s company 2.5 2.2 2.5 6.6 5.8 5.1 6.3 6.2 7.7   Long-term partnership 3.7 2.3 5 6.4 5.9 3.8 6.1 5.1 4.2 7.6 The authors note that public images of manager and salesman, commitment of salesman to the buyer-seller friendship and the willingness of manager and salesman to return each other favours are highly correlated to each other (shown in bold in the table). Their findings also complement the findings of Andrew Kipnis on his study of guanxi (Kipnis, 1997). The authors also observe that among the elements of guanxi, commitment to friendship is most-strongly related to reliance on salesman. In fact, favour-returning negatively affects reliance on salesman. Conclusion The findings of the literature indicate that guanxi, as a whole, is very important in building trust and reliance of the buying manager on the salesman of the seller, but if elements of guanxi are examined separately, only commitment to the friendship between the manager and seller facilitates building-up of manager’s trust. This complements the findings of Lewicki and Bunker that the feeling of reliability and dependence created by display of commitment is stronger and more durable than cognitive cues such as, self-image and favour-returning (Lewicki and Bunker, 1995). The study confirms the importance of interpersonal relationships of buying manager and salesman in building strong trust and long-term partnerships between buying and selling companies. Reference List Central Finance University of China, 2005. Quanguo dixia jinrong diaocha (Nationwide survey on informal finance). Beijing: Central Finance University of China. Chen, M., 2003. Inside Chinese Business: A Guide for Managers Worldwide. [online] Available at: [Accessed 26 December 2013]. Chinese University of Hong Kong, 2004. Service Centre version of the SAIC Private Enterprise Survey. Hong Kong: Chinese University of Hong Kong. Fornell, C. and Larcker, D., 1981. Evaluating Structural Equation Models with Unobservable Variables and Measurement Error. Journal of Marketing Research, 18(1), pp. 39–50. Katz, D. and Kahn, R., 1978. The Social Psychology of Organizations. New York: John Wiley & Sons. Kipnis, A., 1997. Producing Guanxi: Sentiment, Self, and Subculture in a North China Village. North Carolina: Duke University Press. Lee D. and Dawes, P., 2005. Guanxi, Trust, and Long-Term Orientation in Chinese Business Markets. Journal of International Marketing, 13(2), pp. 28–56. Lewicki, R. and Bunker, B., 1995. Trust in Relationships: A Model of Development and Decline. California: Jossey-Bass. Li, J. and Hsu, S., 2009. Informal Finance in China: American and Chinese Perspectives. [online] Available at: [Accessed 26 December 2013]. OECD Publishing, 2005. OECD Economic Surveys: China 2005. [online] Available at: [Accessed 26 December 2013]. Tanaka, K. and Molnar, M., 2008. What Is Different about Informal Finance? Financing of Private Firms in China. Revue economique, 59(6), pp. 1131-1143. Weitz, B. and Jap, S., 1995. Relationship Marketing and Distribution Channels. Journal of the Academy of Marketing Science, 23(1), pp. 305–320. Read More