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Taking the bite out of loan sharks

THE city of Wenzhou is never lacking in news. Almost every week or two, something new pops up about financial changes in the city.

This week's official visit by People's Bank of China Governor Zhou Xiaochuan marks another watershed in a city often hailed China's "capital of entrepreneurship."

The central bank governor said Wenzhou's financial regulator should "loosen its grip on private lenders," and "bravely explore measures" to make full use of the financial resources in the city.

His words suggest that a gray area in city financing needs better definition. More specifically, Zhou seemed to be saying that it's okay for private lenders to operate in the city as long as they conform to best business practices. For that, the city needs to lay out a regulatory framework that gives private lenders more freedom but requires they operate more transparently.

There have been a lot of calls for the central government to allow private lending into the nation's banking system as a means of increasing credit to small and medium businesses.

That concept was somewhat tarnished last year with reports out of Wenzhou that small businesses seeking loans from loan sharks were being charged interest rates sometimes exceeding 100 percent and being subjected to violent coercion if they fell in arrears. Some borrowers were forced into bankruptcy. Others fled the scene, leaving thousands of workers without jobs.

A mixture of urgency and uncertainty has added to the unprecedented drama of Wenzhou lending.

Whatever the details of reform measures, they should contain two essential elements: providing safety and ensuring profits.

A government-backed body should be created to absorb private lenders' risks of bad loans. A fair system that assesses the creditworthiness of lenders and borrowers needs to be established. Flexibility to lend according to marketplace conditions must be insured.

When Wenzhou's private lending system fell apart last year, branches of state-owned banks in Zhejiang Province rushed in to save the day by paying off the debts that had gone sour, and new rules on private lending were proposed.

But the situation doesn't seem to have improved all that much since then. About 60 debt-laden business owners fled during the first two months of this year, taking the total 234. Among the cases, 152 owed a combined 4.1 billion yuan (US$651 million), accounting for about 36 percent of bad loans of the city, according to a report by the banking regulator in Wenzhou.

Zhou's visit came after China's State Council, or Cabinet, chose the city as a pilot for a series of financial reforms late last month.

Of course, verbal support from such high-ranking officials may be encouraging for local regulators, but more concrete actions are needed to allow private lenders to make legitimate profits while complying with industry standards.

Private lenders, who have enjoyed high returns operating in an unofficial realm without regulation, aren't likely to welcome new rules. It's a bit like the Wenzhou government trying to enlist outlaws into an official army.

Then, too, folks with abundant capital and a savvy business sense can usually find ways to get around regulations they don't like.

If the Wenzhou regulator really wants to clean up the loan sharks and bring private lenders into the mainstream credit system, it should provide an attractive platform for them to operate. Even in the gray market, there are rules that govern business behavior. The government needs to take those rules into consideration, protect the rights of lenders, adopt incentives to gain their confidence and ensure that the private-lending realm isn't swallowed up by official institutions.

To set up a government guarantee body may help private lenders find qualified business borrowers and absorb, to some extent, the risk of lending. That would go a long way toward cleaning up the current mess where companies end up providing guarantees for one another, creating a domino effect if one fails.

A statement posted on the website of the People's Bank of China yesterday discussed the establishment of a government-led and market-oriented credit rating system, which would certainly make the lending system more transparent.

The government grip on interest rates and on financial industry entry thresholds should be gradually loosened, and more channels for credit created.

Reform always involves a redistribution of interests. Mainstream banks may lose some of their market share if controls are loosened, and some companies that are used to thriving on excessive borrowing from private lenders may go belly-up.

And finally, there's no guarantee that privately owned banks will really fill the yawning gap in small-business lending created by big banks that have generally refused to lend to capital-thirsty start-ups.

The reform ideas being bandied around now may as well end up as hollow rhetoric.


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