China Is Trying To Crush Shadow Banking By Legalizing It

people's bank of china, China central bank

Photo: AP Images

China is rolling out a few pilot reforms and one in Wenzhou, a hotspot for illegal lending, is going to allow informal lending institutions to register as private lenders or become rural banks.Problems with China’s massive 14 – 15 trillion yuan shadow banking sector have been brought to the forefront by the death sentence meted out to 28-year old Wu Ying.

Policies aimed at curbing speculation and preventing a property bubble are widely blamed for a severe credit crunch and a resurgence in underground lending.

Societe Generale analyst Wei Yao says the thriving shadow banking sector shows a desperate need for funds among small and medium enterprises (SMEs), or that many are involved in unproductive, speculative activity.

If successful, legalizing informal lending could break what many see as the monopoly of state banks in China and meet the funding needs for SMEs. If rolled out nationally, it would significantly increase sources of lending for SMEs and help spur on economic growth.

But the success of this reform depends largely on the willingness of these banks to register with the state. While the move would grant them access to a wider ranger of customers and allow recourse in cases where borrowers default on their loans, they would likely have to cede to interest rates far lower than the 20 – 180 per cent they were used to.

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