UPDATE 1-China's rate cuts fall flat as small firms bypass banks
(Adds complaint letter from private firms on inability to roll over loans)
By Koh Gui Qing
BEIJING, July 18 (Reuters) - China's bid to energise a stuttering economy by cutting interest rates twice in a month and making it more attractive for banks to take risks on private sector borrowers is falling flat with the country's most dynamic job generators -- smaller firms.
Twin moves to cut and deregulate interest rates have effectively chopped borrowing costs by up to 170 basis points, a potentially eye-popping squeeze on bank lending margins.
Still, that rate-reduction has not been nearly enough to tempt a dozen small factories and wholesalers around Beijing visited by Reuters in the wake of July's policy shift.
Red tape and tough collateral requirements mean business owners prefer to borrow from family and friends to expand in good times and, with the economy in its worst downtrend in three years, the inclination to take on bank debt is close to zero.
"Business this year has fallen by two-thirds compared to last year," said a bed linen seller surnamed He, who last took a bank loan in 2009 for 400,000 yuan ($63,500).
Beijing's crackdown on home purchases, which has hurt his sales, has made it easier still to ignore regular text messages from banks to his mobile phone urging him to borrow.
There are pockets of bustle in a nearby wholesale consumer goods market, touted as the biggest of its kind in north China. But a silk-blouse seller named Zheng typifies a reluctance to borrow that troubles economists and policymakers alike -- complaining that bank debt is too hard to secure and unnecessary with business so slow.
China needs firms to spend to keep creating jobs and guard against the risk of growth falling below the government's 7.5 percent target this year. It came close in the second quarter, with the economy expanding just 7.6 percent on the same period in 2011.
With small- and medium-sized firms (SMEs) accounting for about 60 percent of China's economic output and 75 percent of its jobs, they are a huge potential spur to activity.
In China, the parameters of what constitutes a small or medium enterprise vary greatly, depending on the sector. They can have fewer than 10 employees or up to 2,000 staff, and their annual revenue can be as little as 500,000 yuan or 2,000 times more, at 1 billion yuan.
SMEs have not always shied away from banks. A year ago, they complained about a lack of financing, after a monetary policy tightening campaign resulted in banks channelling most lending to behemoth state firms, choking off funds to others.
Since November 2011, China has freed an estimated 1.2 trillion yuan for new lending by cutting 150 basis points from the proportion of deposits that banks must keep as reserves.
But if SMEs don't borrow, big state businesses may be forced to - a dangerous echo of the state-led binge of 2008-10 that left local governments with 10.7 trillion yuan of debt and banks nursing bad loans estimated at 2-3 trillion yuan.
Louis Kuijs, a project director at the Fung Global Institute in Hong Kong, says a relapse would risk state firms frittering loans away on wasteful investment, something the government says it wants to discourage and that its reforms aim to change.
Reforming SME credit is a key concern for the director-general of Asian Development Bank's East Asian Department, Robert Wihtol.
"It relates directly to the shift to a more consumer-driven, services driven economy," Wihtol told Reuters on a recent visit to Beijing. "This is a key issue that the government is going to have to address. Small and medium-sized enterprises do not have adequate access to the financing they need."
Although loan growth to small businesses outpaced overall lending growth in the first quarter, SMEs are still complaining that the banking system isn't doing enough.
Domestic media reported on Tuesday that 600 private firms in Hangzhou, southwest of Shanghai, publicly submitted a letter to the Zhejiang provincial government complaining that banks are refusing to roll over loans and otherwise ease access to credit.
But for some small businesses, more bank loans won't solve their cash problems.
A toy seller, Zhu Ping, says it only makes sense to borrow from a bank if she wants at least one million yuan -- and she does not want that much.
"It's pointless borrowing several hundred thousand yuan from a bank," she said in her shop packed with toy cars, pink castles and plastic building blocks. "Just pick any family and it would have that money to lend."
Such unregulated lending drives a shadow banking system, worth an estimated 10 trillion yuan, that analysts say puts China's financial stability at risk.
In an industrial park in the southern part of Beijing, a finance manager at a high-speed train maker said low interest rates will not entice her firm to borrow more to expand, because it does not have land beyond what it has already pledged as collateral to banks. In China, land remains banks' preferred collateral.
"Lowering interest rates does not address the fundamental difficulties (for borrowers), such as stringent guarantee requirements that banks ask from small companies," the finance manager said. (Additional reporting by Pete Sweeney and Gabriel Wildau in SHANGHAI; Editing by Nick Edwards and Richard Borsuk)
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