China legalizes private lending in Wenzhou

China will start testing the waters of legalized private lending on Saturday in the pilot city of Wenzhou, where a liquidity crunch in underground lending in 2011 caused a credit crisis.

Zhang Zhenyu, deputy secretary-general of the municipal Communist Party of China Committee and head of the city's finance reform office, told Xinhua Friday that detailed rules of the regulation, which were finalized this week, will take effect on Saturday along with the regulation.

The Wenzhou Private Financing Regulation, passed by the Zhejiang Provincial People's Congress in November 2013, says that enterprises in need of funds can borrow private loans via three kinds of intermediary agencies, including private capital management firms, financing information service firms and lending service institutions, which are still not part of the formal financial system elsewhere in China.

Wenzhou's lending service institutions emerged in 2012, when the State Council approved a broad package of financial reforms allowing Wenzhou to serve as a testbed for liberalizing private lending, which had grown into a colossal underground industry, powered by the robust growth of the city's private economy.

These institutions keep record of lenders who lend over 3 million yuan (about half a million U.S. dollars) in a single private loan and collective loans with a combined value of over 10 million yuan.

There are currently seven such service centers in Wenzhou. By December 12, 2013, they had registered private capital of 7 billion yuan, with 2.5 billion in outstanding loans.

Wenzhou also has 11 private capital management firms, which specialize in offering financial services from private placement to project investment. By December, they had directed 2 billion yuan in private funding for investment in 618 commercial projects.

Zhu Zhongming, vice mayor of Wenzhou, said the city has set up an administrative system to regulate private financing activities. It is composed of a financial management bureau, a financial arbitration institution, a financial crime investigation team and a court.

The new regulation, with seven chapters and 50 clauses, specifies regular private financing operations, risk control measures and legal liabilities.

WHY WENZHOU?

Wenzhou in east China's Zhejiang Province is one of the country's birthplaces of private economy. Private businesses took off through selling small commodities like cigarette lighters, buttons, spectacles and shoes to the world market. It was common that small businesses unable to get credit from government-owned banks took risks to borrow from underground lending.

However, the rates charged by informal lenders were often higher than bank interest rates, some of which were exorbitant, which made it almost impossible for firms to repay the loans.

With China's economy pushing against the limits of a growth model, firms were finding it more difficult to yield enough profits to pay back loans with high interests.

The 2011 rupture of the capital chain led to hundreds of bankruptcies of low-cost manufacturing enterprises. Many business owners fled or even committed suicide. Some local underground bankers also committed suicide after failing to repay debts.

According to a survey by the Wenzhou Branch of the People's Bank of China in 2011, 89 percent of households in the city and 60 percent of local firms were involved in private financing with total capital estimated at 110 billion yuan.

Due to the large capital, Wenzhou's credit crisis sparked fears of a nationwide financial crisis.

Wenzhou was chosen to pilot the private financing reform, partly because the State Council hoped the effort could help bail out private investors from the credit crisis.

The central government also proposed various ways for big state-owned banks to increase lending to private firms in Wenzhou, although banks complained that the lack of credit bureaus made it hard to assess the riskiness of such loans.

During the reform, the city introduced in 2012 the "Wenzhou Index," a comprehensive interest rate index for non-governmental financing. It opens the floating index of anonymous ratings of firms including small-loan companies, pawn financing interest rates and private borrowing rates.

The new regulation follows market norms to protect lenders and borrowers.

A Wenzhou private enterprenuer surnamed Ye said he narrowly escaped the 2011 credit crisis.

He said his machinery manufacturing business demands a large capital flow. He has borrowed 4 million yuan from a finance service institute.

He said many private businesspeople are concerned that the capital registration requirement in the regulation would put private lending information under government supervision, and lenders also have to be charged tax on their incomes.

"I've learned from my experience from the crisis that when a debt dispute happens, it is better to have had the lending deal on record in a financial service agency, which protects interests of both parties," he said.