Fintech ecosystem can benefit from innovation

Fintech, as a major task of China's future economic development, aims to establish a virtuous cycle among technology, industry, and finance while driving innovation-led productivity and advancing the country's technological self-reliance.

The growth of endogenous technological innovation is both a prerequisite for sustained technological progress and a foundation for robust long-term economic growth in China.

However, tech-driven enterprises often face challenges in securing financing due to their high-risk, high-reward, and asset-light nature. Traditional financial institutions, such as commercial banks, struggle with issues like asset valuation, credit history, and lack of collateral.

Currently, China's fintech ecosystem is grappling with shortcomings, including an underdeveloped equity market, lagging high-yield bond market, limited integration between banks and venture capital, slow progress in intellectual property financing, and the need for ecosystem enhancements.

The declining contribution of technological innovation to China's economic growth is partly linked to the diminishing latecomer advantage of external technological progress.

Over the past four decades of reform and opening-up, domestic innovation has played a critical role in technological advancement, but the importance of exogenous technological progress cannot be overlooked.

Specifically, China has long benefited from importing, absorbing, and adapting foreign technologies for local application. However, since the global financial crisis in 2008, the pace of external technological progress in China has slowed significantly.

One reason for this slowdown is that as domestic technological progress accelerates, the gap between China and the world's leading technologies has narrowed. This makes the acquisition of cutting-edge international technology more expensive and less accessible.

Another reason is the increasing wariness of major developed countries toward China's rise, which has led to intensified efforts to impose technology blockades and restrictions.

In the foreseeable future, the scope for external technological progress will become increasingly constrained, making it imperative for the Chinese government to effectively stimulate domestic innovation.

The growth of endogenous technological innovation is not only essential for sustaining China's technological advancement, but also critical for ensuring the country's continued robust economic growth.

The process of technological innovation can be broken down into three stages: invention, innovation, and the diffusion of innovation. To transfer from invention to innovation and then to the diffusion of innovation, enterprises must overcome two "valleys of death". Successfully navigating these stages requires strong support from government policies and financial systems.

Developed countries have created comprehensive equity financing systems tailored to the life cycles of tech-driven enterprises, offering diversified and relay-style financial services.

Additionally, tech companies in these markets can raise funds through bond issuances. In the United States, a collaborative "investment-loan linkage" model involving commercial banks and VC and PE funds has been developed to jointly fintech enterprises.

In China, fintech development still faces several significant challenges. First, the broad equity market encounters a range of interconnected issues. The long-term returns of the stock market are notably lower than those of developed countries, and policies related to the stock market are heavily administrative, leading to difficulties in equity investment exits in the primary market.

Moreover, the scale of China's VC and PE markets has significantly shrunk compared to their peak, with foreign participation markedly declining.

According to market consultancy Zero2IPO Group, in the first three quarters of 2023, most large RMB-denominated funds were initiated by State-backed managers. All funds exceeding 10 billion yuan ($1.38 billion) had State-owned backgrounds, while 87 percent of funds with a 5 to 10 billion yuan range also had such ties.

State-led equity investment funds, primarily established by local governments, play a key role but often emphasize short-term returns, resulting in a more conservative investment style compared to private funds.

To ensure successful investments, local governments frequently offer additional support in areas like market access, environmental regulations and land use, effectively reducing investment risks but potentially undermining the local business environment.

Additionally, many VC and PE funds in China lack sufficient specialization. Strong fund performance depends on expertise, particularly in specific industries requiring long-term, in-depth research.

Second, the development of China's high-yield bond market lags behind other segments of its bond market. Although China has become one of the largest bond markets globally, the high-yield segment is still in its infancy.

Third, Chinese commercial banks have limited involvement and effectiveness in investment-loan linkage programs targeting tech enterprises. While some commercial banks have experimented with such programs, they are typically confined to collaborations between their credit and equity investment divisions or subsidiaries, rather than forming regular partnerships with external VC and PE funds.

Fourth, China's intellectual property market remains underdeveloped, with significant deficiencies in IP valuation, standardization, and liquidity, which hinder the expansion of IP-based financing.

Finally, China has yet to establish a well-integrated fintech ecosystem that fosters close collaboration among governments, universities, enterprises, VC/PE funds, and capital markets.

To tackle these challenges, accelerating market-oriented and rule-of-law reforms in China's stock market is crucial. Efforts should focus on attracting long-term capital, such as pension funds, to increase the proportion of patient capital in the stock market.

China should enhance the accessibility of its VC and PE markets for foreign investors while fostering professionalism and market-oriented growth among domestic funds. For government-backed equity investment funds, the emphasis should shift from short-term profitability to long-term outcomes. Addressing challenges in tax incentives, talent policies, entry restrictions, and exit mechanisms will further optimize the investment environment.

Commercial banks should collaborate with VC and PE funds to create a "technology banking" model tailored to the Chinese market. This model would foster close cooperation and information sharing among banks, funds, and tech enterprises, reducing information asymmetry and associated risks.

Establishing national and regional IP markets, supported by third-party institutions, is key to improving IP valuation, standardization, and liquidity. Innovations in IP financing include combining various IP assets as collateral, implementing multiparty financing models involving banks, governments, and guarantors, and developing asset securitization products based on IP-backed loans.

Strengthening cooperation among governments, universities, enterprises, financial institutions, and capital markets is essential. Promoting entrepreneurship and cultivating tech leaders will help foster innovation while inspiring younger researchers and students to pursue similar paths.

Policy banks can play a significant role in financing major national innovation platforms. Drawing from Germany's experience, policy banks could offer differentiated loans at lower-than-market rates, collaborate with commercial banks to improve efficiency, and invest in equity to bolster the capital base of tech companies.

A credit assurance system that combines central and local government efforts, guarantees, and insurance could mitigate risks. For example, creating a fintech risk compensation fund, streamlining the re-guarantee system, and establishing government-backed financing guarantees would enhance credit support. Germany's guarantee banks provide a model, offering loans to small and medium-sized enterprises with a shared risk mechanism involving commercial banks and government backing.

By addressing these key areas, China can strengthen its fintech infrastructure, fostering innovation and ensuring sustainable economic growth.

The views do not necessarily reflect those of China Daily.

The writer is deputy director of the Institute of Finance and Banking, which is part of the Chinese Academy of Social Sciences.