China's private lending market is estimated at about 2 trillion yuan (292 billion U.S. dollars) a year, and it's often the only source of credit in rural areas, but its growth has been constrained by its underground status.

However, private lending might soon occupy a more legitimate place in the country's capital markets, analysts said, with the People's Bank of China (PBOC) having decided to grant it legal status.

In a statement on its website posted Feb. 20, the PBOC -- the central bank -- said it would formulate regulations on private lenders and develop the sector into "a significant player" in the country's rural money markets. It hasn't said when the new regulations would take effect.

Zheng Fengtian, vice dean with the Agriculture and Country Department of Renmin University of China, said the move was "absolutely necessary," since the economic slowdown would aggravate the perennial problem of capital shortages in rural areas and harm employment and agriculture.

TOUGH RURAL TIMES

The government has warned that this year would be "the toughest" since the turn of the century, with the global downturn having cost about 20 million rural migrant workers their jobs.

The government has urged laid-off workers to become entrepreneurs, but without access to funds, it would be tough to start a business, said Zheng.

China's countryside has had chronic capital shortages since an industry reshuffle in the late 1990s forced most state banks to withdraw from rural areas, leaving behind only the Agricultural Bank of China, rural credit cooperatives and postal savings banks.

These institutions haven't filled the void, however, with many limiting lending for fear of bad debt and low profits. Returns from rural lending are low, while risks are high. Some institutions even forbid rural outlets from lending without higher-level approval.

As a result, said analysts, most of the savings that rural residents put into financial institutions have been used to finance production and business in much wealthier cities. The analysts said that the demand for rural credit now being satisfied by the underground market is equal to about 10 percent of China's total personal savings deposits

"To some extent, they [local financial institutions] act like water pumps, exhausting local financial resources," said Zheng.

SEEKING FASTER IMPROVEMENT

Noting the capital shortages in the rural market, the government took steps over the past two years to improve the situation.

At the end of 2006, the China Banking Regulatory Commission (CBRC) relaxed the conditions of entry for banking institutions in rural areas, allowing investors to set up new types of rural financial institutions such as township and village banks and rural mutual cooperatives.

The minimum registered capital for rural cooperative banks, for example, was reduced from 20 million yuan to 10 million yuan, and that for rural credit unions, from 10 million yuan to 5 million yuan.

For bigger township and village banks, the bottom line was set at 1 million yuan, while loan companies and rural mutual cooperatives were required to have registered capital of 500,000 yuan and 100,000 yuan, respectively.

As of the end of 2007, 38 new types of rural financial institutions had obtained licenses, including 25 township and village banks, four loan companies and nine rural mutual cooperatives, according to a speech by Jiang Liming, the deputy director general of the CBRC's Cooperative Finance Supervision Department in Dallas, Texas, last May.

These institutions held 14.7 trillion yuan in aggregate assets, 27.9 percent of total banking assets. Their total loans outstanding related to agriculture reached 6.09 trillion yuan, of which direct agricultural loans amounted to 1.57 trillion yuan.

The proportion of rural households having access to bank loans reached 33 percent, which benefited more than 300 million farmers.