, the administrative cost of sme loans is on average 5 times that of large enterprises. if there is too strict restriction on lending rate, banks may have little incentive to conduct feasibility assessment for sme projects. as a result smes will have limited access to bank loans and thus face more severe situation. hence, we shall change the traditional way of thinking and encourage commercial banks to price the risk associated with sme loans so that they can explore new source of profits. of course, it might to some extent increase interest expense of smes. nevertheless, it is less important compared with the increased access of smes to loans. in particular, some high - tech and high - risk enterprises and private enterprises will benefit. since the people ’ s bank of china removed the ceiling on lending rates on october 28, 2004, we have observed that some banks began to utilize the new policy to foster their risk pricing capacity. of course, the government and social intermediaries can help smes reduce risk and financing cost through risk sharing and compensating measures. on the one hand, guarantee institutions shall be supported through such market operations as recapitalization and improved risk control mechanism. on the other hand, local governments can diversify the systemic risks associated with guarantee for sme loans through direct guarantee or re - guarantee. with risk of sme loans shared, they will be subject to less risk premium and lower lending rate. iii. reform of credit system management with respect to smes credit system management involves banks ’ credit management, risk control, asset disposal and supervisory mechanism. in recent years, with the deepening of china ’ s financial reform, banking sector has been increasingly aware of credit risk, leading to centralization of credit approval power and opposition of smes. on the one hand, local branches of commercial banks have less power to approve credit and most loan requests had to be reported to branches of provincial level or even the headquarter. as a result, it takes a long time and sophisticated procedure to process loan application, making it hard to meet the financing needs of local smes. on the other hand, local branches of commercial banks in the lagged areas have become ‘ savings bank ’, which transfer the savings to developed areas that need large amount of money. the savings bank thus could earn spreads, while the local enterprises could not obtain credit. frankly speaking, the centralized management pattern is in line with the development trend of international banking industry. however, it needs to be adjusted

for bank regulatory rules to rein in the excessive credit expansion of the commercial banks. the result was that bank rules were not fully implemented and capital ratio was notably inadequate. in fact, the basel accord is a comprehensive regulatory and internal assessment system. its essential indicator, capital adequacy ratio embraces earning objective while effectively containing the excessive expansion of the bank. the numerator of car indicates the capital adequacy of the bank and robustness of the buffer against shocks. the more capital, the more resilient a bank is against risks. meanwhile, dynamics of capital depends on retained profit. when a bank calls for additional capital, the investors look at the earnings of the bank. an unprofitable bank can hardly attract external finance. in addition, expansion through merger and acquisition is also subject to capital constraint. the denominator of car assigns different risk weights to assets so as to drive banks towards less risky business and away from high risk business. risky business must be supported by more capital. this effectively contains the excessive growth of risky assets. the basel ii initiated the so - called “ internal rating base ” ( irb ), encouraging banks to identify asset risks through internal rating system. the risk weighting system encourages non - asset business, or commission - based business. the accord will also boost asset securitization since securitization lowers risk level of assets thus lowers capital requirements. in a way, it encourages banks to shift, sterilize and lower risks by all means. in this sense, such an indicator is a combination of incentive and control mechanisms, while encouraging technical innovations to improve credit asset quality. nevertheless, a principal problem in applying car to chinese banking institutions is that different banks bear different historical legacy, which is difficult to measure by a unified standard. this historical problem should be solved by more aggressive reforms before more stringent regulations could be applied and serve as the core objective to improve their corporate governance and business operation. in this spirit, in 2003, the china banking regulatory commission initiated the 3 - year plan for banks to comply with basel ii. some technical issues deserve attention, which, if not properly dealt with, may dampen the effectiveness of the policy. for instance, for banks with inadequate capital, the so - called “ shadow calculation ” may leave a lot of leeway. for banks with lower than 4 percent of capital adequacy ratio, strict regulatory measures have been taken. however, for banks with capital ratio sliding down