China's financial regulator is shifting the focus of its approach to small-business lending away from aggressive loan growth targets toward higher-quality and more sustainable credit support that better aligns with the real financing needs of micro and small enterprises as well as the broader economy.

The National Financial Regulatory Administration recently issued a notice calling for efforts to promote financial services for such enterprises by "stabilizing credit supply, optimizing credit structure, improving quality and ensuring sustainability".

Previously, China's banking and insurance regulator had set core requirements for small business financing that focused on increasing loan volumes, including ensuring that the growth rate of loans to micro and small enterprises was no lower than the average growth rate of all loans.

Dong Ximiao, deputy director of the Shanghai Institution for Finance and Development, said the financial regulator is no longer imposing a nationwide rigid assessment target for loan growth rates. Instead, it now emphasizes reasonably determining the scale of inclusive loans to micro and small enterprises, prioritizing effective quality improvement before quantitative growth, and truthfully and accurately reflecting the quality of credit assets.

This will guide financial institutions to accelerate the transformation of their evaluation systems and push small business financial services further from a scale-first approach toward a quality-first approach, Dong said.

Xue Hongyan, a special researcher at Jiangsu Su Merchants Bank, said that as revenues of micro and small enterprises are currently fluctuating significantly, overemphasizing loan expansion could lead banks into excessive competition, inflated loan figures and loosened risk controls, while also increasing the debt burden on businesses.

As the pressure from performance evaluations eases, banks can allocate more credit resources to high-quality enterprises, optimize their credit structure and improve their risk-based pricing capabilities, thereby enabling micro and small enterprises to access more targeted financial services. This will help prevent structural risks in the financial system and foster a healthier ecosystem, Xue said.

Data from the NFRA show that as of the end of the first quarter, the outstanding balance of inclusive loans to micro and small enterprises by banking institutions reached 38.79 trillion yuan ($5.72 trillion), up 9.9 percent year-on-year.

Behind the rapid expansion in small business lending, however, deeper structural contradictions have become increasingly prominent. Dong said that in order to meet performance targets and cope with intense competition, some banks engaged in data falsification during the loan issuance process by inflating loan volumes, fabricating borrowing entities and colluding with loan brokers, resulting in the misallocation of financial resources intended for small businesses.

Wang Runshi, a distinguished research fellow at the Shanghai Institution for Finance and Development, said that some banks had previously kept loans that should have been classified as nonperforming in the pass or special-mention categories by rolling over old debt with new loans, processing loan extensions in violation of regulations and artificially adjusting repayment schedules.

Failure to truthfully reflect asset quality not only obscures the true level of financial risk, but also allows a large amount of credit resources to be occupied by inefficient enterprises, preventing funds from genuinely benefiting small businesses with real financing needs, Wang said.

To address these violations and mitigate risks for small business finance, the NFRA stressed stronger monitoring and analysis of asset quality, accurate loan risk classification, greater support for write-offs and improved efficiency in disposing of nonperforming loans. It also specifically calls for strengthened management of loan renewals and the truthful and accurate reflection of the asset quality of renewed loans.

Analysts said the NFRA's renewed notice on improving financial services for micro and small enterprises will help ensure that credit resources are precisely directed at the real economy, thereby safeguarding employment and people's livelihoods and supporting stable economic recovery.