Small businesses in China for a long time have depended on small firms, wealthy investors, and loan sharks for funding. Some of these tactics, depending on the terms, are illegal, but often times have been the only source for small businesses in need of loans. This is the case because China’s major state-owned banks focus on lending money to large enterprises that are owned by the state. The Chinese government has recently announced that authorities are looking for ways to legitimize this informal-lending sector, in hopes of transforming existing underground lenders into licensed investors and potentially small-loan companies.
Government officials have repeatedly urged state banks to lend to smaller businesses, but it has been to no avail. Regardless of these pleas, the current, formal financial sector is not equipped to fully bridge the funding gap. Premier Wen Jiabao sums up China’s need for the informal-lending sector when he says, “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.” He added that clearly defined legal safeguards would be necessary for informal loans.
Last year in Wenzhou, a city known as a center of private enterprise and informal lending, more than a dozen businesses owners shut down their businesses due to tightened monetary conditions in Beijing, which made it an even greater challenge to access credit or repay high interest loans. These business owners proceeded to leave town, leaving their creditors behind without repaying their loans. The hope is that a legal, evolved informal-lending system with safeguards would prevent events like this from reoccurring.
If this informal lending system becomes legitimate, China as a whole would gain. Small businesses would have access to licensed investors, and state banks would be able to continue loaning exclusively to large, state-owned firms. Do you think this system will be beneficial if enacted? Feel free to leave your thoughts and comments below!