By Ma Hongman

It is reported that a regulation drafted by the central bank on private lending has been submitted to the State Council, the country's cabinet, for review. The regulation is due to allow individuals and companies to extend loans if they do not have bad credit or criminal records. If approved, it will mean domestic banks' monopoly in the country's credit market will be broken and non-public lending legalized.

Private credit business has long been labeled "underground banking" in China. The move by the central bank, the country's prime financial monitor, to legalize it indicates the long-thriving business in some coastal regions can come out in the open from its previous backstage operation.

The move will be of great significance to the introduction of competition to the country's financial market that has long been dominated by State-run banks.

It also indicates the authorities' strong intention to rope in non-government capital to make up for an insufficiency in the official capital market.

The global financial crisis has forced China also to face a grim economic prospect.

A number of domestic enterprises, especially middle and small-sized ones, are being plagued by severe funding insufficiency because of the bleak external consumption demands.

The lack of steady capital supply will further erode these enterprises' waning ability to endure the coming economic cold and thus will add to a further shrinkage in social investment and demands.

Worse, this will evolve into a vicious cycle. A key to breaking the stalemate lies in a vigorous injection of outside fund.

However, the established commercial banking system alone seems unable to shoulder such a heavy responsibility.

The authorities have suspended an index limitation on banks' credit scale and turned to a moderately loose monetary policy, but these have not reversed the country's contracting credit business.

Statistics show lending by domestic financial bodies increased by 181.9 billion yuan ($26.48 billion) in October, which was the lowest growth rate compared with the foregoing months. With a large number of struggling enterprises thirsty for life-saving funds, it is really a pity that domestic banks with abundant funds still remain over-prudent and reluctant to offer a helping hand.

Under these circumstances, the central bank's intention to open up the unofficial lending channel is expected to ease the current embarrassing situation.

If the domination of domestic commercial banks over the domestic credit market is broken, the long-sluggish lending business is likely to make a new breakthrough.

In the long run, opening domestic credit business to individuals and companies will also help improve efficiency in the distribution of social resources.

However, any possible imperfections in the preliminary-stage development of the private credit market may set limits on its development and expansion.

Experiments by some small-scale creditors in the country, however, point to another problem. They show that quite a number of unofficial lending bodies may find it difficult to meet the requirements set by relevant State departments, although they have established a well-developed apparatus to run their daily business.

There are two big obstacles for less powerful unofficial credit agencies to achieving a bigger stride forward.

The relevant regulations stipulate that the practitioners should possess banking business experiences and should have a certain level of academic background.

However, for a majority of these lending bodies, what they have resorted to is a skillfully utilized network of social relations as a main means to monitor possible financial risks in their business.

This kind of risk control model, although very different from the models used by bigger commercial banks, has proved highly efficient in the smaller-scale unofficial credit market.

Take an obscure cooperative bank in Wenzhou, Zhejiang province as an example. The eastern coastal province is well known for its booming middle and small-sized enterprises.

The rural cooperative financial body, set up in June 2005 and with nearly 4,000 farmers among its 4,639 shareholders, extended a total of loans worth 4 billion yuan last year, 60 percent of them flowing to rural areas.

The bank achieved a profit of 112 million yuan the same year. Its great success has made establishment of similar financial agencies the most tempting investment target in the city.

One of the effective measures used by the bank to minimize its potential risks is to put any borrowers with bad credit records on a blacklist, which, alongside others, will contribute to the defaulters being deserted by the local society.

The outstanding business achieved by the Wenzhou rural cooperative bank, managed by not so highly educated shareholders, fully demonstrates the existence of financial wisdom at the grassroots.

It is true the government should set some entry standards for the unofficial credit business from a long-term perspective.

But the authorities should also try to extend some preferential polices to the fledgling sector in its transition to formal financial bodies.

The opening of the sector will surely help the country's struggling medium and small-sized enterprise to survive the financial winter ahead.

The author is an anchorman with China Business Network, a TV network based in Shanghai.

(China Daily November 19, 2008)