Legitimizing Private Lending

China unveils a pilot program for private financing By Liu Xinlian

Legitimizing Private Lending

China unveils a pilot program for private financing By Liu Xinlian

China’s widespread private lending market, widely known but unofficially recognized, is getting special government treatment in the wake of credit calamities in Wenzhou, Zhejiang Province,China’s private financing hub. A comprehensive financial reform pilot area is in the works for the city, said Premier Wen Jiabao at a State Council meeting on March 28.

The pilot area should encourage and guide private capital to enter the field of offi cial fi nancial services, ensure smooth access to investment channels for private capital and improve the financial services to small and micro-enterprises and rural areas, according to Zhou Xiaochuan, Governor of the People’s Bank of China, the central bank.

By carrying out the reform, Wenzhou should be able to effectively improve the capability of turning private capital into industrial capital, Zhou said.

Wenzhou’s large number of active private lenders and small businesses are the main reason for the government’s decision to launch the pilot program in the city. Of fi cial statistics show that the private capital in Wenzhou amounted to 600 billion yuan ($95.2 billion)last year. Small and medium-sized enterprises accounted for 99 percent of the city’s total.

“The reform will pull Wenzhou’s real economy out of the predicament it now finds itself in and regain the reputation of Wenzhou’s private enterprises,” said Zheng Chen’ai, Director of Wenzhou Fashion Association.

“The government aims to test the waters through Wenzhou and then accumulate experience for the nationwide reform,” said Guo Tianyong, Director of the Research Center of China Banking Industry at the Central University of Finance and Economics.

Why Wenzhou?

The establishment of the comprehensive financial reform pilot area in Wenzhou will serve two purposes: bringing underground private lending in the sunlight and regulating private lending, said Zhang Zhenyu, Director of Wenzhou Finance Of fi ce.

The private lending industry in China was estimated to have grown to 4 trillion yuan ($634 billion) last year, according to a research report issued by CITIC Securities based in Beijing.

In Wenzhou the size of this industry was about 180 billion yuan ($28.57 billion), with nearly 90 percent of the city’s residents involved in the loan-shark business, according to the Bank of Wenzhou, the biggest local commercial bank.

According to Fang Peilin, Chairman of Wenzhou Fang Xing Guarantee Co., which helps small companies get loans by providing guarantees to lenders, the monthly interest rate for private lending in Wenzhou reached 3 percent.

“The extraordinarily high interest rate was unreasonable for enterprises, because the average profit margin was no more than 15 percent,” said Ma Jinlong, former Director of Wenzhou People’s Government Economic Research Center.

As the credit crunch unfolded last year,bosses of companies that faced bankruptcy or had run out of funds took fl ight, boarding up factories and abandoning their businesses.

After the private lending default last year, the original private lending system based on personal trust almost broke down, Fang said.

Although the government vowed to increase lending to smaller enterprises, stateowned banks that dominate the Chinese banking sector prefer to lend to well-connected state firms that can all but guarantee that the money will be repaid. Wenzhou’s credit crunch last year has made lending for small enterprises even more dif fi cult to come by.

With banks unwilling to provide small and micro-companies with financing, these companies have had nowhere to turn for capital but private, underground lenders.

The idea of changing Wenzhou’s financial environment first emerged in late 2011, and the long-awaited decision came as underground private financing activities in Wenzhou have stirred up financial disputes and crime while threatening Wenzhou’s financial and economic stability.

Highlights

The reform program will cover 12 major tasks, including regulating and developing private fi nancing, encouraging individual funds to set up rural banks or small lending companies, supporting lending by state-owned banks to smaller businesses and allowing individual investors to make direct overseas investment.

CFP

Right now, the government is studying the implementation of a fi le management system for private financing and improvements to the monitoring system.

According to the program, informal moneylenders will be encouraged to register as private lending institutions free to operate with the blessing of the state.

The participation of private capital—in the form of setting up or taking shares of rural banks and credit companies—is encouraged and supported in the reform process. Eligible micro-finance companies could be transformed into rural banks. Private funds will also be guided toward the establishment of venture capital and private equity activities as well as other types of investment bodies.

“The program points out the direction where the private capital should be channeled to. The registration requirement for private capital will turn underground private lending into formal lending above it,” said Zhang Yili,Vice Dean of the School of Business with Wenzhou University.

“After private moneylenders are registered as legal institutions, the government can effectively supervise their operations and establish regulations,” Zhang Yili said.

As it stands, illegal private banks are weak and collapse easily under the slightest pressure because they have no legal protection.

“Registration is the first step to governmental supervision,” said Ma.

The government vowed to encourage the establishment of fi nancial leasing enterprises that serve small and micro-enterprises as well as sectors concerning farmers, agriculture and the city’s rural areas. It will also encourage qualified state-owned and share-holding banks to set up special units to deal with credit grants to small enterprises.

According to Fang, financial leasing enterprises are currently only permitted in Tianjin, Shanghai and Guangzhou of Guangdong Province.

“With the establishment of fi nancial leasing enterprises, the private entrepreneurs in Wenzhou will be able to rent the manufacturing equipment from the financing leasing enterprises,” Fang said.

Other measures of the pilot program include standardizing and legalizing transactions of non-listed companies’ shares, technologies and cultural properties, encouraging small and micro-companies to issue bonds in Wenzhou,setting up guarantee mechanisms for small and micro-companies, and encouraging commercial insurers to participate in the establishment of a social security system.

It’s a positive signal, but it’s also too early to judge the real effects without speci fi c rules to support the program, said Cheng Huifang, Dean of the College of Economics and Management at Zhejiang University of Technology.

The government will also examine a pilot scheme that will allow Wenzhou residents to make direct offshore investments by creating regular and convenient direct investment channels. If it is approved, Wenzhou will become the first city to allow individuals to directly invest overseas, Zhang Yili said.

According to Chen Derong, Secretary General of Wenzhou Municipal Committee of the Communist Party of China, the financing problem for Wenzhou is not lack of money, but excess liquidity and lack of investment channels.To address Wenzhou’s excess liquidity, the city launched an individual overseas investment program last year, but it was suspended weeks later.

Suitable supporting policies are crucial to the successful implementation of the pilot project, said Ding Zhijie, Dean of the School of Banking and Finance at the University of International Business and Economics. Since China’s capital accounts are still relatively closed, the pilot project in Wenzhou will be limited to direct overseas investment, but authenticity tests and other regulatory measures remain necessary.

SEALING A DEAL: Zhou Jianhua (left), the boss of a shoe manufacturer in Wenzhou, Zhejiang Province,signs a contract with a micro-loan company