China’s Tech Funders Worry They Could Be the Next Silicon Valley Bank
Financial innovation has been a powerful force, but the specter of inflation looms.
The downfall of Silicon Valley Bank (SVB) initially rattled China’s tech startups and venture capitalists (VCs). Thus far, its direct impact on China’s tech and venture capital industries has been minimal. Nonetheless, the second biggest bank failure in U.S. history serves as a warning to Chinese policymakers and banks that a lack of risk management and inadequate regulatory oversight creates a toxic brew that can overflow quickly.
The downfall of Silicon Valley Bank (SVB) initially rattled China’s tech startups and venture capitalists (VCs). Thus far, its direct impact on China’s tech and venture capital industries has been minimal. Nonetheless, the second biggest bank failure in U.S. history serves as a warning to Chinese policymakers and banks that a lack of risk management and inadequate regulatory oversight creates a toxic brew that can overflow quickly.
Before its recent demise, SVB succeeded in addressing the needs of the entire lifecycle of capital within the startup ecosystem by providing tailored services, such as venture debt lending and asset management for startups and VCs. SVB gained deep insights into investment trends and built an extensive network of people and expertise by investing in many leading venture capital firms through its fund of funds. The success of SVB’s business transcended the geographic confines of Silicon Valley, allowing it to have an important presence in the tech communities in China, Europe, and Israel, among other places. But it was also a business that turned out to be built on the back of historically low interest rates—and when a combination of inflation and panic among VCs sparked a bank run, SVB couldn’t survive.
While it is hard to replicate the entirety of SVB’s service, expertise, and network by any other institution, the success of its venture debt model for tech financing has been the envy of Chinese financiers. Some Chinese banks have adopted SVB’s venture debt financing model to bolster the development of small and medium-sized tech firms. This practice aligns with President Xi Jinping’s ambition to improve tech self-reliance amid escalating tensions with the United States. These banks could suffer the same fate as SVB if the People’s Bank of China (PBoC) tightens monetary policy, suggesting China’s tech ambitions are vulnerable to inflation. In this context, the PBoC has to maintain a low-rate environment to meet the dual needs of financing China’s tech self-reliance and boosting the post-COVID economic recovery.
Since 2014, the PBoC has largely continued easing monetary policy. China’s benchmark one-year loan prime rate (LPR)—the benchmark lending rate for Chinese banks introduced in 2019—was about 4.3 percent throughout 2018 and mid-2019. Since then, the PBoC has conducted several interest rate cuts, taking the one-year LPR down to 3.7 percent by August 2022 to boost its economy. China’s interest rate for small and medium-sized enterprises (SMEs) was 4.84 percent in 2020, down 0.02 percentage points compared to 2019. To give this some context, the U.S. prime rate was between 4.5 percent and 5.5 percent between 2018 and mid-2020, whereas interest rates for a typical U.S. Small Business Administration loan ranged from 6.25 percent to 8.75 percent as of 2022.
SVB itself had a long operating history in China, dating back to 1999. The bank established its first Chinese subsidiary in Shanghai in 2005 and a second in Beijing in 2010. In August 2012, SVB launched a pioneering 50-50 joint venture with Shanghai Pudong Development Bank. The joint venture, Shanghai Pudong Development Silicon Valley Bank (SPD-SVB), was the first tech bank in China and had an initial registered capital of RMB 1 billion, which subsequently increased to RMB 2 billion.
Between 2016 and 2021, SPD-SVB obtained approval to launch subsidiaries in Beijing, Shenzhen, and Suzhou, focusing on eight industries: health care, green and intelligent manufacturing, enterprise services, semiconductors, artificial intelligence and big data, financial technology, new consumption, and industrial internet. Its clients included Chinese companies focusing on the domestic market, including AI giant SenseTime and bike-sharing firm Mobike. The 2021 annual report of SPD-SVB revealed that about 98 percent of the firms it served were indigenous Chinese science and technology companies. As of the second quarter of 2021, SPD-SVB served more than 3,000 corporations, highlighting its impressive market penetration in China’s tech industry. Following SVB’s collapse, its Chinese joint venture moved quickly to clarify its independence, stating that it maintains a separate balance sheet, implying that the demise of SVB has had no impact on its financial health.
Despite the failure of SVB, the venture lending model it championed has been instrumental in the success of several high-tech industrial development zones supported by regional banks—city commercial banks in particular—that aspire to become the Chinese equivalent of SVB. Contemporary Chinese city commercial banks originate from the urban credit cooperatives in the 1980s, when local governments and enterprises established joint stock commercial banks to meet the needs of an opening economy.
To give an example, Hankou Bank, the largest city commercial bank in Hubei province, was among China’s first municipal commercial lenders to adopt SVB’s venture lending model to finance tech-based SMEs in the Wuhan East Lake High-Tech Development Zone, which is also known as the Optics Valley of China. Local government and party material boasts repeatedly of its success in the global optoelectronic market. Xi visited the Optics Valley three times between 2013 and 2022.
Hubei Daily, the official newspaper of the Chinese Communist Party in Hubei province, reported in October 2009 that Hankou Bank launched Hubei’s first “specialized subsidiary to finance tech SMEs with indigenous intellectual property rights and cutting-edge inventions” in strategic sectors, such as electronics, space, information technology, biotech, new materials, and new energy. In 2010, Hankou Bank established a technology financial service center in Optics Valley, explicitly aspiring to become China’s SVB and serve the national strategy of promoting science and technology innovation. In 2016, it became one of the first 10 qualified banks to do venture loans. By the end of 2022, the bank had provided over 230 billion yuan in credit to about 4,500 tech firms.
Bank of Hangzhou is another typical city commercial bank that has followed the SVB model and catered to the unique financing needs of tech SMEs. Hangzhou hosts the headquarters of several leading tech startups in China, including Alibaba, and the city, a provincial capital, topped the Economist Intelligence Unit’s China Emerging City Rankings as the city with the greatest growth potential for several years, ahead of Shenzhen and Shanghai. In 2009, it led the way in Zhejiang province to launch a dedicated subsidiary to finance tech SMEs, with an explicit mission to become Hangzhou’s SVB. Notably, in 2010, the bank expanded to China’s Silicon Valley, Zhongguancun, becoming one of the first to support SMEs to raise capital via equity pledge financing on the National Equities Exchange and Quotations, commonly referred to as the New Third Board. After that, Bank of Hangzhou continued to lead the charge in financing technology ventures, launching a specialized technology finance department in 2016 and opening a branch in the Shanghai Science and Technology Innovation Center in 2021.
Such local experiments with the SVB financing model paved the way for Beijing to encourage broader implementation of this approach. In April 2016, China Banking and Insurance Regulatory Commission (CBIRC), the Ministry of Science and Technology (MOST), and the PBoC jointly issued a “Guiding Opinions on Supporting Banking Financial Institutions to Increase Innovation and Implement the Investment-Loan Linkage Pilot Program for Science and Technology Innovation Enterprises,” which set the policy course for lower-level government institutions.
The pilot programs laid out in the scheme targeted five “national independent innovation demonstration zones” in Beijing, Wuhan, Shanghai, Tianjin, and Xi’an. Wuhan East Lake High-Tech Development Zone was one of these five pilot programs. The Guiding Opinions designated 10 banks to lead the implementation of the investment-loan linkage program, including one policy bank (China Development Bank) and two national banks (Bank of China and Hengfeng Bank) authorized to finance projects in all five demonstration zones. It also allowed SPD-SVB to fund projects within its existing business scope and authorized six regional banks to finance projects in demonstration zones within their jurisdictions. These six regional banks were the Bank of Beijing, Bank of Tianjin, Bank of Shanghai, Hankou Bank, Bank of Xi’an, and Shanghai Huarui Bank.
In light of stringent export controls imposed by the West, China has to find alternative means to achieve technological advancement, as trading market access for cutting-edge technologies is no longer optimal. Chinese policymakers are exploring the use of SVB-style banking and venture loans to support tech SMEs and the development of high-tech zones. Over the past two years, China has launched various R&D financing pilot programs. For example, in November 2021, the State Council approved the “Master Plan to Build a Pilot Zone of Financial Reform to Support Science and Technology Innovation in Jinan,” the capital city of Shandong province.
This plan aims to establish a financing supply chain for the entire technology and innovation pipeline, which is exactly what SVB achieved. A year later, eight government agencies—including the PBoC, Ministry of Finance, CBIRC, China Securities Regulatory Commission, and four others—jointly issued the “Master Plan to Build Pilot Zones of Financial Reform to Support Science and Technology Innovation in Shanghai, Nanjing, Hangzhou, Hefei, and Jiaxing.”
This is the first plan for a multi-city pilot zone. According to MOST, as of 2022, China had established at least 23 national independent innovation demonstration zones in 66 national high-tech zones across 60 cities, many of which have adopted SVB’s model. MOST has been drafting a “National Independent Innovation Demonstration Zone Development Plan for 2021-2035,” which will likely encourage the nationwide application of the SVB-style equity-loan venture finance for Chinese tech startups.
Yet now this model is looking much shakier. The fall of SVB shows sharply that poor risk management combined with loose financial supervision quickly creates financial instability in a rising interest rate environment. This warning holds for Chinese banks that aspire to be the next SVB. Apart from the China Development Bank and Bank of China, the remaining eight designated banks are not necessarily the best at risk management, and their track record is far from spotless.
For example, Hengfeng Bank underwent a 100 billion yuan ($14.5 billion) restructuring in 2019 after corrupt management brought the bank to the brink of bankruptcy. In 2018, the bank’s nonperforming loans ratio reached 28.44 percent, or the colossal amount of 163.56 billion yuan. Even after restructuring, Hengfeng Bank has been struggling. Between August 2021 and September 2022, Hengfeng Bank and its subsidiaries were fined 10 times by Chinese regulators, amounting to a total fine of 9.25 million yuan. Recently, the bank has been unable to recover 658 million yuan from two investments into two subsidiaries of the same real estate developer, Rongqiao Group.
The Chinese government is certainly aware of the dangers. Chinese regulators and state-owned insurance providers have proactively developed risk management solutions to support China’s indigenous R&D in strategic industries, especially semiconductors. In December 2021, CBIRC issued “Guiding Opinions on the Banking and Insurance Industries Supporting Advanced Technology Self-Reliance and Self-Improvement.” The Guiding Opinions encourage the investment arms of commercial banks, insurance institutions, and trust companies to participate in venture capital funds and government industrial investment funds and provide equity financing to support tech firms in need of capital. Later the same month, 18 Chinese insurance and reinsurance companies jointly established an Integrated Circuit Co-Insurance Company to provide industry-specific risk solutions for China’s indigenous chip developers.
As China navigates a challenging geopolitical landscape, these efforts to promote domestic innovation through venture debt financing, regulatory reform, and supervision strengthening represent a serious commitment to improving indigenous science and technology development capability. However, it is worrisome that China’s regional commercial banks have been actively financing high-tech development zones and tech SMEs. Although SVB’s failure has not discouraged the Chinese government and banks from using venture debt to support Chinese tech SMEs and advance self-sufficiency in strategic sectors, it has triggered a reevaluation in China regarding the SVB financing model.
Yi Gang, governor of the People’s Bank of China, has offered reassuring remarks that all deposit-taking financial institutions in China have joined deposit insurance, which can provide full protection for more than 99 percent of depositors. Ju Weimin, president and chief investment officer of China Investment Corporation, cautioned that “while the direct cause of the fall of SVB is asset-liability maturity mismatch and liquidity mismatch, the root cause is that the old business model is obviously insufficient in adapting to new paradigms, which means similar risk events may occur in the future.” Ju’s comment applies to Chinese banks. Financial instability among these municipal lenders could directly threaten China’s indigenous technology innovation capacity by suffocating Chinese tech SMEs.
A low-interest rate environment has been a boom for Chinese banks to provide venture debt financing to burgeoning tech startups, which in turn supports Xi’s push for tech self-reliance. Additionally, low rates have also underpinned China’s post-COVID economic rebound. All these suggest that China’s various political-economic pursuits are highly susceptible to the specter of inflation.
Given the imperative to advance these objectives, the PBoC may find itself hamstrung in its ability to utilize interest rates as a tool to manage financial instability risks and inflation if the rise in prices were to outpace actual economic recovery. Should the PBoC persist with expansionary measures, it could in turn impede western central banks’ effort to combat inflation.
Zongyuan Zoe Liu is a columnist at Foreign Policy and the Maurice R. Greenberg Fellow for China Studies at the Council on Foreign Relations. Her latest book is Sovereign Funds: How the Communist Party of China Finances Its Global Ambitions (Harvard University Press, 2023).
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