Ｓｍａｌｌ Ｌｏａｎｓ，Ｍｉｇｈｔｙ Ｉｍｐａｃｔ

ＺＨＡＯ　ＦＥＩ

WENZHOU has cultivated the most vibrant private capital market in China, estimated conservatively at RMB 342 billion by the Wenzhou Branch of the Peoples Bank of China, or a steeply higher RMB 600 million by other experts. Chinas Banking Regulatory Commission published Advice on Experiments with Small Loan Companies in May of 2008, clarifying the nature of these financial entities and setting rules for their operation. It is widely believed this is a move by the state to give private capital its long awaited legitimacy. So far eight small loan companies have been established in the city, all closely watched by the financial sector of the nation.

Life Buoy to SMEs

“Without the RMB 500,000 loan, our factory would have gone bankrupt,” Mr. Zheng acknowledged gratefully about the sum the printing factory he manages has just received from the Ruifeng Small Loan Company, Yongjia County. The gloomy economic situation has compounded the stress on funding, leaving small businesses nationwide scrambling. With an old bank loan coming due and the application for a new one not yet approved, money-strapped enterprises usually have no way to get out of this limbo except by resorting to a small loan company.

Private businesses accounted for 80.9 percent in Wenzhous GDP in 2008. The 300,000 small and medium-sized enterprises (SMEs), combined with a lavish reserve of private capital, lay the foundation for small loan companies to thrive in the region. Zhang Zhenyu, chief of the Finance Office of the municipal government, believes that small loan companies fill the gap between financial institutions and private lenders, and points out that a customer base has already formed among small businesses and residential communities.

“Our company mainly serves small enterprises, and notably those involved in agriculture and the countryside,” said Pan Xianyong, general manager of Ruifeng Small Loan Company. “The loan term is generally no more than six months, and a mortgage is not always required.” For small loan companies like Ruifeng, the process from starting the credit inquiry to releasing the loan takes as little as a couple of hours. “We never read the customers financial statement. For many companies that approach us the general manager is the husband, and the accountant is his wife. Any figures they present have little value as a reference. Our client managers look at the electricity bills instead.” Mr. Pan knows that the volume of power consumption is the best indicator of an enterprises productivity, particularly the manufacturing ones.

According to local government figures, Wenzhous small loan companies, eight in total, can process an application in a brief period ranging from three hours to three days. Eighty-five percent of their loans are unsecured. Two of the small loan companies do not require mortgages to release loans. These companies accept account receivables as security on loans to businesses at the upper and lower reaches of industrial chains, where financial risks are deemed greater. In Yueqing City, for instance, transactions with pig farms are settled every three months. Once a loan company is convinced the payment will arrive on time, it simply extends the loan to the farm.

By the end of March 2009 the eight small loan companies in Wenzhou had made RMB 2.05 billion available to more than 3,000 small businesses, many of them involving agriculture and the countryside. “Most small loan companies confine their business to their home turf in towns and villages, where people have known each other for many years. A few chats are all that is needed to check someones credit status. Such loan inquiries are efficient, economical and effective,” explained Zhang Jun, deputy secretary general of the Center for Private Economic Studies under the Chinese Academy of Social Sciences. Of all the small loans made in Wenzhou, the default rate is less than 1‰ or RMB 400,000 – a record that would please any financial establishment in the world.

No Easy Business

Lianxin Small Loan Co., Ltd. in Cangnan County was the groundbreaker for small loan companies in Wenzhou. Its 18 percent capital circulation rate is so far the highest among its peers. Chen Kaiyun, one of the founders, acknowledged that the company is performing well, but insisted modestly that “by ‘investors criteria our profits are far lower than investment in other trades.”

At present interest on loans is the only legal revenue for small loan companies. Despite performing above the benchmark interest rate – 10 to 20 percent – this income is subject to taxes imposed on generic companies, meaning a 25 percent income tax plus a 5.56 percent business tax. The tax rates for banks are 12.5 percent and 3 percent respectively. Taxes like this bite deep into small loan companies profits.

To add to the challenges, these independents are constantly grappling with the short supply of capital, being prohibited as they are by law to solicit savings, enter inter-bank borrowing/lending arrangements, or make entrusted loans. When Lianxin opened, it loaned out all its RMB 100 million of registered capital in less than a month. “At the end of last year more than 200 enterprises applied for loans with us, but we had money for only half of them,” Chen Kaiyun recalled. It is the same problem with Ruifeng, which lent RMB 29 million on the first day of its operation, a sizable chunk of its total RMB 150 million. General Manager Pan Xianyong joked that the company entered a semi-closure state after dispensing all its money.

“Fund shortage is the major obstacle for the growth of small loan companies,” warned Zhang Jun. “If the problem is not solved, it is tempting go to the verge of breaking the law.” So far, small loan companies are banned from raising public funds or accepting money deposits. These regulations are intended to control risks, but they also effectively clip the wings of small loan companies, leaving them stranded between commercial banks and individual lenders. Once they have dispensed all their money, the temptation is high to go around the legal limits to sustain their operation. The consequences can be wrist-slapping fines, admonition, or in extreme cases, abolition. The last was the fate of the Rural Cooperative Fund, which, in its maturity, had tens of thousands of outlets nationwide but was dismantled by the state in its 15th year of operation.

Big Potential

“Many people are aware of the problems afflicting small loan companies, but are still willing to enter the sector. What draws them in is the future of the business,” said Zhou Dewen, president of the SEMs Association of Wenzhou. In China it is next to impossible for private investors to establish banks. As an option, sliding into the finance business through a small loan company allows them, under current regulations, to upgrade into rural banks.Upgrades are granted on application if the business has maintained a smooth operation and solid reputation.

Nevertheless Zhang Jun is strongly opposed to the idea of transforming small loan companies into banks, saying big shareholders, most likely state-owned banks, would definitely overwhelm private investors. He gave the example of a rural bank in Cangnan County controlled by the China Construction Bank, which has been completely patterned on its sponsor. Word is about that Zhejiang Province is considering a plan to redefine small loan companies as a new rural financial organization. Zhang Jun welcomes that move, thinking it a better avenue for small loan companies to push the envelope. How far they could go would depend on the extent of government support.

In the opinion of Zhang Zhenyu in Wenzhous Finance Office, it is possible for small loan companies and big commercial banks to strike good deals if cooperating on an equal footing. He suggested a “combined loan”: a format where a loan contracted to a small loan company by a commercial bank is granted, and collected, by the former. If the sum is RMB 2 million, the ceiling of RMB 500,000 for small loan companies can be charged at the interest rate for small loans, and the remainder computed at the lower benchmark rate. In this case, the commercial bank would pay commission fees to the small loan company, and the latter take all the risks.

Zhang Zhenyu expects the number of local small loan companies to grow to 20 within two years, holding total assets of RMB 20 billion – equivalent to that of a single commercial bank. That should meet the demand of the SMEs in Wenzhou.