China's private lending market is estimated at about 2 trillion yuan (US$292 billion) a year, and it's often the only source of credit in rural areas, but its growth has been constrained by its underground status.

However, private lending might soon occupy a more legitimate place in the country's capital markets, analysts said, with the People's Bank of China (PBOC) having decided to grant it legal status.

In a statement on its website posted on February 20, the PBOC -- the central bank -- said it would formulate regulations on private lenders and develop the sector into "a significant player" in the country's rural money markets. It hasn't said when the new regulations would take effect.

Zheng Fengtian, vice dean with the Agriculture and Country Department of Renmin University of China, said the move was "absolutely necessary," since the economic slowdown would aggravate the perennial problem of capital shortages in rural areas and harm employment and agriculture.

Tough rural times

The government has warned that this year would be "the toughest" since the turn of the century, with the global downturn having cost about 20 million rural migrant workers their jobs.

The government has urged laid-off workers to become entrepreneurs, but without access to funds, it would be tough to start a business, said Zheng.

China's countryside has had chronic capital shortages since an industry reshuffle in the late 1990s forced most state banks to withdraw from rural areas, leaving behind only the Agricultural Bank of China, rural credit cooperatives and postal savings banks.

These institutions haven't filled the void, however, with many limiting lending for fear of bad debt and low profits. Returns from rural lending are low, while risks are high. Some institutions even forbid rural outlets from lending without higher-level approval.

As a result, said analysts, most of the savings that rural residents put into financial institutions have been used to finance production and business in much wealthier cities. The analysts said that the demand for rural credit now being satisfied by the underground market is equal to about 10 percent of China's total personal savings deposits

"To some extent, they [local financial institutions] act like water pumps, exhausting local financial resources," said Zheng.

Seeking faster improvement

Noting the capital shortages in the rural market, the government took steps over the past two years to improve the situation.

At the end of 2006, the China Banking Regulatory Commission (CBRC) relaxed the conditions of entry for banking institutions in rural areas, allowing investors to set up new types of rural financial institutions such as township and village banks and rural mutual cooperatives.

The minimum registered capital for rural cooperative banks, for example, was reduced from 20 million yuan to 10 million yuan, and that for rural credit unions, from 10 million yuan to 5 million yuan.

For bigger township and village banks, the bottom line was set at 1 million yuan, while loan companies and rural mutual cooperatives were required to have registered capital of 500,000 yuan and 100,000 yuan, respectively.

As of the end of 2007, 38 new types of rural financial institutions had obtained licenses, including 25 township and village banks, four loan companies and nine rural mutual cooperatives, according to a speech by Jiang Liming, the deputy director general of the CBRC's Cooperative Finance Supervision Department in Dallas, Texas, last May.

These institutions held 14.7 trillion yuan in aggregate assets, 27.9 percent of total banking assets. Their total loans outstanding related to agriculture reached 6.09 trillion yuan, of which direct agricultural loans amounted to 1.57 trillion yuan.

The proportion of rural households having access to bank loans reached 33 percent, which benefited more than 300 million farmers.

Enhancing microcredit

To enhance micro credit, the CBRC also expanded the list of qualified micro-credit lenders from rural credit unions to all banking institutions, and it broadened the target industries from planting and breeding to all agriculture-related business.

The size of allowable credit lines was raised from a range of 3,000 yuan to 5,000 yuan to a range of 10,000 yuan to as much as 3million yuan. And loan terms got longer, rising from less than one year to as long as three years. Floating rates were also allowed.

In March 2007, the first three village banks opened in a remote area of southwest China's Sichuan Province and northeast Jilin Province, part of the government drive to provide farmers with easier access to small loans.

Moreover, private-sector and foreign institutions were allowed to participate in rural finance.

In December 2007, the Hong Kong and Shanghai Banking Corp. opened its first rural bank in Hubei Province, marking the first entry by an international bank into a rural area of China.

Still experimenting

However, rural financial reform is still at the experimental stage and more needs to be done to address capital shortages.

"Village banks and other new rural financial institutions have been established in some pilot areas of the countryside in recent years. These institutions need time to expand their coverage and improve services to satisfy more capital-hungry farmers nationwide," said Zheng.

The national 4 trillion yuan economic stimulus plan, announced last November, won't do much to help individual farmers. The plan allocates 370 billion yuan for rural investment, but it will go to livelihood and infrastructure construction over the next two years, according to researcher Li Jing with the Futures and Securities Institution of China's Central University of Finance and Economics.

"Legalizing private lending will help to revive the rural money market under the economic downturn," said Li.

Invisible but important

Private lending is difficult to quantify or control. It refers to capital-raising activities outside of banks and financial institutions. Restricted by its unauthorized status, it is underground and based upon mutual trust between lenders and debtors.

"Private lending is nothing new. Rural households that run a small business have been benefited most. And its advantages compared to formal lending are obvious," said Li.

As loans by informal lenders are made to acquaintances, lenders could easily stay on top of borrowers' credit standing and payment ability. In addition, simple and flexible lending procedures and low transaction costs could better meet small borrowers' needs, he said.

By contrast, borrowing from formal financial institutions would always require rural households to provide collateral.

Popular but pricey

Since the industry is illegal and therefore not regulated, it's hard to determine exactly how big it is. But a number of universities, think tanks and other institutions have come up with a range of estimates.

A survey by Tsinghua University in 2008 showed that about 69 percent of rural households in eight provinces had borrowed from private lenders. The university's Economic Management Institute also found that about 40 percent of the 120 million capital-hungry farmers couldn't borrow anywhere.

The university estimated the capital gap in China's rural money market at 1 trillion yuan last year.

China Development Bank has forecast that the capital shortage in rural China would hit 5.4 trillion yuan by 2010 and 7.6 trillion yuan by 2015 if the situation didn't improve.

Citing his field surveys in Zhejiang and Fujian provinces, Zheng said each private loan in affluent coastal cities usually ranged from 100,000 yuan to 2 million yuan. In rural areas, however, loans could be as small as 10,000 yuan.

For those who got scarce capital, the interest rate was often three to 12 times higher than the benchmark one-year lending rate, which currently stood at 5.31 percent, he noted.

By legalizing and regulating private lending, the government could also clamp down on loan sharks and better protect the legitimate interests of lenders and borrowers, Zheng said.

Suggested regulations

The deputy director of the PBOC's Research Bureau, Liu Ping, said the "biggest breakthrough" in regulating private lending would be to allow individuals to lend, on condition that the loans represented their own capital.

Researcher E Yongjian with the Bank of Communications said that such a restriction would help prevent financing of illegal activities and money laundering.

The required registered capital, credit ceilings and interest rates were still under study, PBOC sources said.

Zheng suggested building flexibility into the regulations to reflect conditions in different regions.

For example, he said, "registered capital requirements should range from 100,000 yuan to 200,000 yuan in underdeveloped western rural regions. In affluent coastal cities, 1 million yuan is considered suitable."

Also, the entry threshold should not be too high.

An even lower threshold, of perhaps less than 100,000 yuan, "would bring in more market players, which would limit room for usury," Zheng said.

(Xinhua News Agency March 4, 2009)