To read the full version of this content please select one of the options below:

Can third party's collateral arrangements tackle the financing problem of small-medium enterprises?

Zheng Hong (Chinese Finance Research Institute, Southwestern University of Finance and Economics, Chengdu, People's Republic of China)
YiHai Zhou (The People's Bank of China, Beijing, People's Republic of China)

China Finance Review International

ISSN: 2044-1398

Article publication date: 28 October 2013

Abstract

Purpose

Faced with the financing problem of small-medium enterprises (SMEs), China has attempted to establish as many as third party's collateral institutions. The paper aims to study the design of collateral arrangements including collateral fee rates, risk sharing, collateral capital requirements, types of collateral institutions and recollateral institution, etc.

Design/methodology/approach

The paper extends the model of Holmstrom and Tirole to develop the analytic framework of the theory of financing collateral. From the perspective of contract design, the paper establishes a moral hazard model focusing on the minimum capital requirement of the borrower under the condition of risk neutral and limited liability, while considering the structure of lender-collateral institution-borrower.

Findings

According to the research, only under certain conditions can third party's collateral arrangements tackle the financing problems of SMEs. Diversification, anti-collateral and linked-transactions are three means to improve financing conditions, but the most important way is efficient monitoring by collateral institutions, especially when it has relative advantage over the lender. In order to improve financing conditions of SMEs, China should rely more on efficient monitoring by banks not on excess development of collateral institutions, meanwhile relax rigid collateral supervision policies. Collateral institutions should be industry-specific, association or transaction-related type.

Originality/value

First, from the perspective of contract design, the paper analyzes the comprehensive institutional arrangements of third party's collateral considering mutual relationships of component elements and develops the analytic framework of the theory of third party's collateral, especially points out necessary conditions of its efficient arrangements. Second, the paper studies various efficient financing mechanisms under the institutional arrangements of third party's collateral and focusing on the role of monitoring and monitors, and the paper also has important policy implications, i.e. the paper should develop specific collateral institutions and promote monitoring role of credit institutions.

Keywords

Acknowledgements

JEL classification – G21, G32, D86 The paper is supported by The National Social Science Fund Project of China “Financial Decentralization and Local Financial Management System”, “The Development and Supervision of Small and Medium Financial Institutions”(12BJY152), and “211” project of SWUFE.

Citation

Hong, Z. and Zhou, Y. (2013), "Can third party's collateral arrangements tackle the financing problem of small-medium enterprises?", China Finance Review International, Vol. 3 No. 4, pp. 353-380. https://doi.org/10.1108/CFRI-08-2012-0094

Publisher

:

Emerald Group Publishing Limited

Copyright © 2013, Emerald Group Publishing Limited