Watch Wenzhou

Watch Wenzhou

Private lenders legalised

Financial reforms got a big boost this week, in the city often said to be at the forefront of China’s bad loan problem: Wenzhou in Zhejiang province. Banks in the city face an NPL crisis – the bad debt pool has more than tripled since June, from just 0.37% to a current 1.74%, reports CapitalVue. It cites analyst predictions that local NPLs could go as high as 2% by the end of 2012, or even 5% if the economy slows significantly.

It shouldn’t be much of a surprise that Wenzhou’s banks are hurting. Last year, the city was at the centre of a debt crunch, brought about by disintegrating networks of private lenders. Many of these ‘private loans’ start out as a bank loan that is ‘guaranteed’ by a local businessman with good credit, before being lent out to less creditworthy borrowers. When the chains of debt collapse, the bank is left with a new NPL.

Beijing’s response, decided in a meeting of the State Council this week, was described as “momentous” by an economist speaking to the China Daily. New rules will allow local investors to invest abroad directly, while at the same time permitting private investors to establish legitimate loan companies.

The changes are presumably designed to ensure that Wenzhou’s entrepreneurs have a broader range of investment opportunities so that they feel less compelled to engage in underground private lending (to make a return on their capital). But if they do decide to go into the loan  business, they can now do so in a more transparent, regulated way.

A communique issued by the State Council describes the changes as “of the utmost importance”, not only for Wenzhou, but also as a first step for wider financial reform.

Indeed, if Wenzhou’s pilot scheme is successful the ramifications will be far-reaching. Not only will Chinese individuals be able to invest more easily abroad – a major loosening of capital controls – but a private sector banking system could emerge to counterbalance the state-owned one. That could then give entrepreneurs much needed access to finance.

Financial reforms got a big boost this week, in the city often said to be at the forefront of China’s bad loan problem: Wenzhou in Zhejiang province. Banks in the city face an NPL crisis – the bad debt pool has more than tripled since June, from just 0.37% to a current 1.74%, reports CapitalVue. It cites analyst predictions that local NPLs could go as high as 2% by the end of 2012, or even 5% if the economy slows significantly.

It shouldn’t be much of a surprise that Wenzhou’s banks are hurting. Last year, the city was at the centre of a debt crunch, brought about by disintegrating networks of private lenders. Many of these ‘private loans’ start out as a bank loan that is ‘guaranteed’ by a local businessman with good credit, before being lent out to less creditworthy borrowers. When the chains of debt collapse, the bank is left with a new NPL.

Beijing’s response, decided in a meeting of the State Council this week, was described as “momentous” by an economist speaking to the China Daily. New rules will allow local investors to invest abroad directly, while at the same time permitting private investors to establish legitimate loan companies.

The changes are presumably designed to ensure that Wenzhou’s entrepreneurs have a broader range of investment opportunities so that they feel less compelled to engage in underground private lending (to make a return on their capital). But if they do decide to go into the loan business, they can now do so in a more transparent, regulated way.

A communique issued by the State Council describes the changes as “of the utmost importance”, not only for Wenzhou, but also as a first step for wider financial reform.

Indeed, if Wenzhou’s pilot scheme is successful the ramifications will be far-reaching. Not only will Chinese individuals be able to invest more easily abroad – a major loosening of capital controls – but a private sector banking system could emerge to counterbalance the state-owned one. That could then give entrepreneurs much needed access to finance.