The Most Revolutionary Act

Wenzhou: birthplace of Chinese capitalism

Last week I was surprised to learn that private lending is illegal in China. In view of the country’s economic miracle, I was even more surprised to learn that small and medium sized enterprises (SMEs), which make up 90% of businesses, are ineligible for start-up or bridge funding from Chinese banks. The latter are still government owned.  The vast majority of Chinese SMEs are financed by private “illegal” loans, amounting to 3.7 trillion yuan or $US 500 billion dollars per year. About half of this financial activity occurs in Zheijiang province, whose most prominent city is Wenzhou, the birthplace of China’s private economy. It’s currently home to 360,000 small businesses that make a major portion of the world’s consumer goods.

70% Interest Rates and “Penalties” for Missed Payments

Until recently, government enforcement of the ban on private lending has been piecemeal and arbitrary. They supposedly go after lenders when the rate of interest exceeds four times the interest charged by state-owned banks (currently about 6%). However many lenders get away with charging interest rates as high as 70%. Borrowers have been happy to pay high rates for start-up funding, owing to the immense profit potential of small factories producing consumer goods for export.

Loans are typically informal. The loan originators pool savings from family members and friends. Borrowers are often friends, as well, and loans are typically agreed with a handshake, rather than a formal contract. People who miss an interest payment get a visit from thugs who beat them up. With the recent slowdown of the Chinese economy, many borrowers, unable to make monthly interest payments have fled Wenzhou. There has also been one high profile suicide.

About 60% of borrowers had taken out loans to invest in the local property boom. When the Chinese government intervened in November to rein in the real estate bubble (by limiting the number of houses people could purchase and increasing the size of deposit required), Wenzhou lenders lost millions of dollars, when loans became tied up in unsellable homes and commercial buildings. At the end of 2011, the shortage of finance capital caused approximately one fifth of Wenzhou’s 360,000 SMEs to cease operating – owing to the unavailability of bridge financing.

Death: the Government Penalty for Usury

In the most high profile illegal lending prosecution, Wu Yung, one of China’s most famous multi-millionairesses was sentenced to death in 2009 for charging an “unreasonably high rate of interest.” The 2011 credit crunch, as well as the uproar Wu Yung’s sentence provoked in the legal and small business community, has spurred the Chinese government to legalize and reform private lending. They are starting with a pilot program in Zheijan and Shenzhen province, based on legislation drafted by Zhou de Wen, head of Wenzhou’s small and medium business association. It will provide government support for the creation of numerous small private funding institutions, including rural banks, micro-financing firms and most importantly,  a private equity fund run by the city government, to invest in its private companies.

In a separate but related development, the Chinese supreme court has commuted Wu Yung’s death sentence and ordered her retried.