News, Cover

Aug 29, 2011

Translated by Zhu Na

Original article: [Chinese] 

Deputy Prime Minister Wang Qishan recently asked local governments to pay close attention to private lending, curb illegal financing, and guard against systematic risk. These efforts may well focus on private lending.

Of course we need to heed the risks, but not all private lending should be eliminated. Regulation is important, but there are gaps in China’s financial service system, and small and medium-sized enterprises often become the victims of tight monetary policy. Private lending should be seen as a supplement to formal financial activities. High interest rates on private loans are beyond regulators’ control. Such “usury” exists for a reason.

Most local governments treat private lending as a grey area; some even tolerate it. Ordos, a city in Inner Mongolian, is a typical example of the flourishing private financial market. The city mainly relies on coal, real estate and private lending, commonly termed the three “engines” of growth. The city’s gross domestic product has been doubling every three years. A senior official of Ordos recently explained to entrepreneurs that the boom in private was due to the inability of the banking system and policy mechanisms to meet demand.

Currently, the sum of all bank lending in Ordos is about 180 billion yuan, and market sources estimate conservatively that private lending exceeds 300 billion yuan. The Ordos official said that local governments don’t encourage such lending, but it still exceeds bank loans. In recent years, the city has allowed private lending to take a beneficial supporting role, while at the same time taking many measures to mitigate the risks, by strengthening supervision.

Like it or not, this attitude is typical of most local governments towards private lending. They want to use it, but fear that it may bring trouble. Local governments don’t want to get involved directly, but are among the major beneficiaries – such lending boosts consumption, employment, land prices, and much besides. It has become one of the supporting factors in maintaining local economic prosperity and keeping funds flowing. Local governments hope to maintain this state, but capital does not always obey the wishes of government officials. According to media reports, the Ordos government introduced “weak” measures to deal with a surge in high-interest private loans.

We think this is where the risk lies. Private lending fills a grey area outside government regulation. Supervision departments cannot control such enormous sums of money. In reality, local governments deliberately avoid it, or even accept its development and growth. The increase of private lending means that once the risks materialize, they can be widespread or even beyond control. But the so called guidance and supervision by local governments is often too difficult to carry out.

This is also what worries the central government. As monetary policy tightens, it becomes difficult for enterprises to borrow money from banks. Local governments and enterprises depend more and more on private financing, and the shortage of funds is continually raising interest rates on these loans. Local governments now worry about systemic risk from private lending. This is because when their fears materialize, private funds, the real economy, social stability and an official’s political performance will all be hit badly.

However, the huge private lending market should be regulated with caution. Even though local governments may have the will for such regulation, they don’t have the means and their efforts could trigger a chain reaction. We believe that local governments should supervise and regulate, either directly or indirectly, those who are involved with large scale private lending activities to avoid serious incidents that would shake social stability. On the other hand, it should legalize private lending so that it can be controlled, and it should actively promote the diversity of financial service institutions to give private funds a proper role in the financial sector.

Therefore, it was a pity that the Lending Regulations, which were focused on private lending, were aborted. If we can legalize private capital by incorporating it within the country’s financial framework of government guidance and market regulation, then these funds, which current sit behind a precarious dam, can to join up with the capital flow within the economy.