Thursday, November 1, 2012

China's parallel lending system

Contrary to what most people think, in China, small and medium-sized enterprises (SMEs) -largely private companies, drive the economy, generating about 60%-70% of GDP and 50% of tax revenues, and providing around 80% of urban jobs. However, less than 15% of bank loans go to SMEs. This is partly due to the fact that financing policies have traditionally favor State-Owned Enterprises (SOE), but it is also the result of cultural habits, since Chinese have favored lending from family, friends and acquaintances much more than lending from banks.

As a result, an informal system of mutual local financing have developed over time. Chinese government did not like very much this private not legal capital chain, this so called "gray-market financing scheme", but did nothing to stop it.

This parallel financing scheme has grown very big, in particular in Wenzhou, where e.g. Henglong Small-loan Company lends to small and micro agricultural enterprises more than 4 billion yuan ($630 million, €480 million). Henglong can set market-driven interest rates up to three times higher than what banks offer, but SMEs still lend from it, among other reasons, because they find it easier to get this kind of financing.

As a result and given the scandal that arose a year ago in Wenzhou around this parallel financing system, China's State Council has set up this year in this area a pilot financial zone legalizing small loan companies. This is considered a first move the government has made to legalize this parallel lending system, which may most probably coexist to the banking lending approach, as well as with all the other financial reforms Chinese government is undertaking towards RMB's internationalization and to transform Shanghai in a world financial centre.

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