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.