Too large to be allowed to die or even catch a severe cold is the exact description of the situation of Stateowned banks in China.

The four biggest State-owned banks occupy 80 per cent of the financial market share, while the small financial institutions are not growing fast enough to meet the demand of small and medium-sized enterprises (SMEs) which develop rapidly and are eager to finance their operation and expansion.

Large or small - which is better? This question has been causing a lot of argument among economists and bankers. Some hold that financial giants or super-banks are more competitive in today's world market, since financial innovation and Internet banking need a great amount of capital to run smoothly.

People are used to looking at the top 100 biggest banks in British journal "Bankers" and are shocked by the scale of their assets. But that is only one side of the story.

Holding a monopolistic position, big banks usually dominate a very large share of financial resources in an economy. Partly because of government intervention, a large proportion of the total deposits is held in a relatively small number of financial institutions in many developing countries and transitional economies.

When problems arise in those big banks, the authorities may be subject to strong pressures to provide deposit guarantees to the problem banks.

Actually, both big and small banks have their basic functions and there exists room for both to grow. In many countries, there are many small and medium-sized enterprises in their earlier stage of economic development, which calls for the support of small banks. Even when they become fairly well developed, small and medium-sized banks remain an important part of the economy, playing a compensatory role for big banks and filling funding shortages.

In today's China, it is an urgent priority to develop small and medium-sized banks.

China is standing at the threshold of economic transformation and ownership structure adjustment. With rapid economic growth since the 1990s, the SMEs have produced 60 per cent of all the gross value of industrial product, contributed 43 per cent of taxation and profit and created 75 per cent of all the jobs.

However, small businesses in China have a limited choice of financial resources. Some businesses can apply for bank loans, but the risks (they have a bigger operation risk and lower credit rating, lack collateral and do not have stable market prospects) still limit their financial opportunities.

Small banks are usually local, which makes it easier for them to check the situation of local SMEs before and after the loan-granting. Their expansion, therefore, should be supported to facilitate SMEs to develop further. This could reduce the risk incurred by the so-called asymmetric information when it comes to dealings between SMEs and big banks.

If it wants to stimulate SMEs and the non-State owned economy, the government should realize it is a big challenge to find ways to finance them for their better operation and expansion. The development of SMEs needs an enlarged number of small and medium-sized financial institutions (SMFIs) to match them.

In fact, however, there are some discriminatory policies against small banks for their branch establishment. They lack a level playing field.

The discriminatory policies should be removed. As long as these SMFIs conform to the financial rules, they should share equal rights with other commercial banks in establishing branches, participating in inter-bank activities and providing other financial services to their costumers.

As things stand, small banks have no way to carry out cross-section settlement, which leads to their liquidity problem and weakens their competitive edge. So a nationwide clearing house system should be set up which provides settlement services for all types of financial institutions.

Of course, there should be a standard for small banks' market entry and exit and their capital adequacy. They should at least meet the requirement of the Bank of International Settlement (BIS) ratio, or the capital adequacy ratio; perhaps even a little higher than that.

As China is a developing country at an early stage of financial development, an insurance system for credit-granting institutions is necessary to protect the interests of small depositors, although there are some arguments pointing to the high cost of financial guarantees, which may distort the perception of risks and lessen the incentives of managers of financial institutions.

We may learn some lessons from other developed nations in setting up a depositary insurance corporation for small and medium-sized banks, which is a partnership among government, central bank and insurance corporations. In such a scheme, all financial institutions who receive individual deposits must have their deposits insured. The fund could be used for bailing out small banks when they meet panic withdrawals and for strengthening depositors' confidence.

At present, the government could also consider setting up specific credit institutions which provide financial services only for SMEs. A credit ranking system is also needed in this case and some financial instruments should be devised for SMEs' financing and settlement.

Shareholding commercial banks have felt the pressure coming from China's WTO entry, but the weakening of the dominant position of big State banks would provide the shareholding commercial banks with opportunities to grab market share.

The competition facing city commercial banks is actually modest, as their customers are typically SMEs and low-income individuals less likely to be targetted by foreign banks.

At the same time, the central bank has issued some policies and measurements to promote financial services for SMEs.

But those measures are not enough to meet the SMEs' demand.

Credit unions should be fostered, which is another way of organizing small and medium-sized banks. Credit unions could provide short-term finance at a relatively high interest rate. The terms for obtaining finance should be much easier than in the banks. Sometimes no collateral is required, and it is enough if one of the credit union members vouches for the newcomer. Most participants of the union can use group credit to finance working capital.

Opening up the country's banking market to more international competition will not only encourage the development of a banking environment which is more in line with international standards, but introduce more foreign capital, together with domestic capital, to strengthen the position of SMFIs during the process of banking reforms.

Financial administration's supervision is also very important for the growth of small banks. The basic responsibility of supervision is to check their financial report and other related information, deal with possible problems and punish them for any irregularities.

The author is professor of economics at Shandong University based in Jinan, capital of East China's Shandong Province.