--Jan Cherim
14 Mar 2012 23:42 CST WSJ: Beijing Considers Legalizing Informal Lending System
By Dinny McMahon
Of THE WALL STREET JOURNAL
BEIJING (Dow Jones)--In a potentially major shift in how Beijing regulates the world's No. 2 economy, China's premier said officials are looking for a way to bring the nation's underground lending system into the light.
China's informal-lending system--a collection of small firms, wealthy individuals, loan sharks and others--has been crucial for the small businesses and rural areas often eschewed by the nation's major state-owned banks, which focus on lending money to big state-owned enterprises. Figures are hard to come by because such lending is unregulated and can be illegal depending on the terms. But UBS AG (UBS, UBS.VX) in October estimated it could be between two trillion yuan and four trillion yuan in total, or $316 billion to $632 billion, or as much as one-tenth of the country's gross domestic product.
Premier Wen Jiabao said Wednesday that authorities are looking at ways to make the informal-lending sector legitimate. His comments come as officials increasingly realize that despite repeated hectoring of state banks to lend more to small borrowers, the formal financial sector is ill-structured to fully plug the funding gap.
Wen said that China's central bank and the China Banking Regulatory Commission are considering launching trial reforms of informal lending in the Chinese city of Wenzhou, a city with a reputation as a center of private enterprise and informal lending.
"We should guide and permit informal capital into the financial arena, standardizing it and bringing it into the open, encouraging its development and strengthening its supervision," said Wen, who was speaking at a news conference marking the conclusion of the annual meeting of China's legislature, the National People's Congress. He also said that informal loans should have clear legal safeguards.
Wenzhou, in Zhejiang province, brought the funding pressures of China's private sector into sharp relief late last year when Beijing tightened monetary conditions, making it even more difficult for the city's small manufacturers to access credit or repay high rates of interest. More than a dozen business owners shut their factories and skipped town leaving their creditors behind, according to state media reports.
Wen's comments were in response to a question about Wu Ying, an entrepreneur in Zhejiang who was sentenced to death for "fraudulent fund-raising."
Wu, at one time China's sixth-richest woman according to Shanghai-based research firm Hurun Report, was found guilty after borrowing as much as 770 million yuan from private lenders whom she promised to pay an interest rate of up to 80%.
Sympathy for Wu has been widespread, partly in response to the extreme sentence meted out for an economic crime. "This incident reflects how the development of informal finance has still not adapted to the development of our economy and society," said Wen.
He added that the Supreme Court had issued a notice on the "careful" handling of informal-lending disputes and was "taking an extremely cautious attitude toward the Wu Ying case."
Economists say the scale of informal lending has recently expanded. Government efforts to tighten monetary conditions since 2010 spurred demand for loans. Meanwhile, many of China's savers and wealthy individuals saw lending out their money as a better investment than banks--which have long offered interest rates lower than the pace of inflation, meaning savers lose money by keeping their cash in deposits--and the stock market, which has been stagnant in recent years.
Now with the economy slowing, the government worries that investors in this unregulated area might lose their savings as borrowers default.
The process of legitimizing informal finance could involve giving existing underground lenders a license to operate as small-loans companies while imposing deposit collection and capital requirements. However, how that works in practice is likely to vary between areas.
Beijing, in efforts in recent years to get credit flowing to those parts of the economy that need it, allowed new types of financial institution to proliferate, including credit guarantee companies, pawn shops, small-loan companies, and microfinancing companies.
Technically informal finance refers to loans without the involvement of such institutions, such as lending between family and friends, between companies, by consortiums of people with excess cash, or underground banks.
But it can also include some of these new-style financial companies who often exceed their charter by collecting deposits and making loans.
(This story and related background material will be available on The Wall Street Journal website, WSJ.com.)
