In the last couple of weeks, the Chinese city of Wenzhou went from economic boom to total bust. Business owners left factories and employees to rot, and it is estimated that the city has racked up $17.2 billion in underground banking loans.
The government has already allowed increased lending the city, but now it’s taking an unprecedented step further, according to China Daily. The city has submitted a proposal to the provincial government to turn it into a pilot zone for entirely private lending, mostly to small and medium sized businesses (SME).
One of the deadliest problems with China’s underground banking system, aside from the fact that it’s untrackable, is that money is lent out at astronomically high interest rates. We’re talking 60% to 180%, and that’s so high that analysts believe that there had to be some kind of speculation going on if borrowers were seriously intending to pay back the loans.
This is particularly dangerous because large, state owned companies were the ones doing most of the lending. And if they didn’t get their money, the reverberations would be felt throughout the economy. Not to mention that a lot of these loans are connected to China’s housing market.
These new private lending platforms will still be allowed to charge higher rates than state-owned banks, but only up to 4 times the standard rate. But to many observers, even with higher rates it’s a step in the right direction.
“In solving the informal lending problem, the government should not focus only on the financing difficulty that SMEs face,” said Yi Xianrong, a researcher with the Institute of Finance and Banking of the Chinese Academy of Social Sciences. “Without adequate supervision, there might be another round of high-interest lending.”