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China eyes shadowy moneylenders to help small firms

China is preparing to bring the country's extensive underground banking system in from the cold as part of attempts to boost lending to small businesses hit hard by the credit crunch and economic downturn.

Informal lending networks, though technically illegal, have been a lifeline for decades for countless businesses that are too small or precarious to be able to borrow from banks, which typically lend to big state-owned or state-backed firms.

With concern growing about a cash crunch at small and medium-sized enterprises, which account for about three-quarters of all jobs created each year, the government is considering bringing these backstreet moneylenders out of the shadows.

Liu Ping, a researcher with the People's Bank of China, said earlier this month that the central bank had completed the draft of a regulation that would make it legal for individuals to extend loans.

“The government is going to accept what it previously wanted to crack down on -- or even get rid of,” said Yuan Gangming, a researcher with the Chinese Academy of Social Sciences, the country's top think-tank.

Estimates of the scale of informal banking range widely. Some studies put it at 10%-20% of total lending in the economy.

Wu Xiaoling, a lawmaker who used to be a vice central bank governor, said legalizing the kerbside market would “give freedom to people who play with their own money.”

China has been experimenting with non-bank lending for the past three years, especially in the countryside, a priority for policy makers keen to narrow the gulf between urban and rural incomes.

In 2007, 31 new-type financial institutions were established, including 19 village and township banks. Citigroup won permission last month to set up two lending firms in rural China.

“A banking system that is fit for big cities certainly is not so fit for rural areas. There are blank areas to be filled,” said Zhao Xijun, a finance professor with the China Renmin University in Beijing.

One finance company that opened last month in the rural fringes of Wenzhou, a bastion of private enterprise in eastern China, is the Yongjia Ruifeng Small-Sum Loan Holdings Co Ltd.

Pan Xianyong, Ruifeng's general manager, said he extended about 50 million yuan in loans within a month of opening on Octöber 18.

The company, which is not allowed to take deposits, expects to have exhausted its initial 150 million yuan in loanable funds within three months.

Pan, with a staff of five, said Ruifeng's customers are generally people “who can't get loans from banks.”

“Some of them don't even have a business license,” he said.

But he said Ruifeng knew its customers and so was comfortable lending to someone with an apparently risky profile.

“We know who he is and who his wife is,” Pan told Reuters. “We know the money won't be wasted on the gambling tables.”

About 100 firms like Ruifeng have received approval in the past few weeks to start business, according to media reports.

One businessman who had been unable to borrow from established banks is Ye Shengtao, who got a 5 million yuan credit line from Ruifeng on the day it opened to run his tea and potato processing firm.

“It's much easier than applying for a loan from a bank,” Ye said. “I applied and got the credit in a single day. It makes my life easier.”

That is why Ye was willing to pay monthly interest of 1.5%, or an annual rate of more than 18%, to Ruifeng.

The authorities are treading gingerly to control the risks of the new finance companies. In Zhejiang province, where Wenzhou is located, they must have registered capital of at least 50 million yuan.

The maximum interest they can charge is four times the benchmark rates set by the central bank - currently 6.66% for one-year loans - and 70% of the loans they extend must be less than 500,000 yuan.

Zhao, the Renmin professor, said the risks were not necessarily greater than those taken by big banks.

“Just look at what happened to the well-established banks on Wall Street,” he said. (Reuters)