VZCZCXRO2756
RR RUEHCN RUEHGH
DE RUEHGH #0342/01 2310828
ZNR UUUUU ZZH
R 180828Z AUG 08
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 7082
INFO RUEHBJ/AMEMBASSY BEIJING 2043
RUEHGZ/AMCONSUL GUANGZHOU 1314
RUEHSH/AMCONSUL SHENYANG 1339
RUEHCN/AMCONSUL CHENGDU 1343
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHHK/AMCONSUL HONG KONG 1489
RUEHIN/AIT TAIPEI 1152
RHEHAAA/NSC WASHINGTON DC
RUEHGH/AMCONSUL SHANGHAI 7658

UNCLAS SECTION 01 OF 03 SHANGHAI 000342 
 
SENSITIVE 
SIPDIS 
 
FRANCISCO FRB FOR CURRAN/GLICK; NEW YORK FRB FOR 
CLARK/CRYSTAL/DAWSON 
CEA FOR BLOCK 
USDOC FOR ITA/MAC DAS KASOFF, MELCHER AND OCEA 
TREASURY FOR AMB.HOLMER, WRIGHT AND TSMITH 
TREASURY FOR OASIA - DOHNER/HAARSAGER/CUSHMAN/WINSHIP 
TREASURY FOR IMFP - SOBEL/MOGHTADER 
NSC FOR LOI 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PGOV CH
SUBJECT: CASH MEETS CAPITAL:  UNDERGROUND FINANCING IN WENZHOU 
 
¶1.  (SBU) Summary:  On August 12, Econoff visited the 
entrepreneurial city of Wenzhou, Zhejiang Province to discuss 
challenges facing small and medium size enterprises (SMEs). 
Interlocutors noted several difficulties brought on by the 
current economic slowdown.  In particular, SMEs have been 
disproportionately affected by government credit tightening 
policies, which have been stepped up recently over concerns 
about inflation.  Underground ("private") lending has helped 
make up for some of the financing shortages faced by SMEs in the 
current credit tight environment, but government interlocutors 
in Wenzhou posit that actual underground lending may be much 
less than has been reported in the media.  Although the local 
government is adopting several measures to increase "official" 
financing channels for SMEs, such as licensing small-sum loan 
companies, local government contacts believe that these measures 
will not play a significant role in China's capital markets when 
credit policies are loosened at some point in the future.  End 
Summary. 
 
Challenges Facing SMEs 
---------------------- 
 
¶2.  (SBU) In separate meetings with Econoff on August 12, Cai 
Lingyue, Vice President of the People's Bank of China (PBOC) 
Wenzhou Branch, and Pan Pingping, Deputy Director of the Wenzhou 
Bureau of Foreign Trade and Economic Cooperation (BOFTEC), 
discussed challenges faced by small and medium size enterprises 
(SMEs).  These challenges include financing, rising costs of 
labor and raw materials, RMB appreciation, and value added tax 
(VAT) rebate adjustments.  Although Pan acknowledged that some 
SMEs in Wenzhou are closing down, he downplayed media reports of 
mass closures as "exaggerated," stating it is "natural" for 
businesses to open and close based on fluctuations in the 
economy. 
 
¶3.  (SBU) In terms of financing, Cai and Pan both noted SMEs 
have been disproportionately affected by government credit 
tightening policies, which have been stepped up recently over 
concerns about inflation.  SMEs account for more than 65 percent 
of total value added of industry in China according to Chinese 
Banking Regulatory Commission (CBRC) statistics; however, these 
data show that SMEs receive only 30 percent of corporate loans. 
In Wenzhou, the concentration of small and medium enterprises is 
higher than the national average, accounting for roughly 80 
percent of value added, by Cai's estimate.  In the current 
environment, it has become increasingly difficult for these 
enterprises to secure adequate financing, as loans to SMEs are 
on average considered riskier than loans to larger firms.  With 
required reserve ratios at 17.5 percent and restrictions placed 
on loan growth, commercial banks lend first to their safer 
clients, usually large firms which have more assets to use as 
collateral. 
 
PBOC Devising New Financing Channels for SMEs 
--------------------------------------------- 
 
¶4.  (SBU) Based on SMEs' contributions to Wenzhou's economy, 
PBOC/Wenzhou's Cai believes it is the PBOC's "responsibility" to 
develop policies and institutions to aid SMEs.  Cai said PBOC is 
encouraging the Postal Savings Bank of China, rural banks, small 
loan companies, and other small financial institutions to meet 
SME financing needs.  Cai also noted the PBOC is actively 
promoting the development of intermediary markets, notably loan 
retailers to direct loans to SMEs, and is also working with 
small financial institutions to help improve risk management. 
He added that the recent PBOC decision to increase loan quotas 
by 5 percent and 10 percent for the five main national banks and 
local banks respectively is aimed primarily to help SMEs, small 
farms and rural industries. 
 
Underground Lending Provides Some Relief 
---------------------------------------- 
 
¶5.  (SBU) According to Cai, the primary financing channels for 
 
SHANGHAI 00000342  002 OF 003 
 
 
Wenzhou SMEs include bank loans, direct financing or trust 
loans, underground lending (loans made outside of officially 
sanctioned channels) and loans from other financial institutions 
such as credit unions, pawn shops and collateral companies. 
Though bank loans are still the primary source of capital for 
SMEs, underground lending has also played a significant role in 
covering SMEs' capital shortages.  Although Cai believes private 
lending has its advantages, he emphasized its risks, notably its 
lack of transparency and undermining of Central Government 
macro-control policies.  He also downplayed its weight, claiming 
it accounts for 10 percent of current total lending in Wenzhou 
as opposed to 30 to 40 percent in the 1980s. 
 
Who Has the Right Numbers? 
-------------------------- 
 
¶6.  (SBU) The newspaper Wen Weipo, citing experts familiar with 
underground lending, reported the practice could account for up 
to 30 percent of all lending in China.  Likewise, a University 
of International Business and Economics (UIBE) Professor 
estimates underground lending accounts for 25 percent of all 
lending activity.  Comment:  Given the relatively high 
concentration of privately owned SMEs in Wenzhou and suspicion 
that most underground financing goes to SMEs, Cai's estimate 
that 10 percent of total lending in Wenzhou is from private 
lending suggests (though anecdotally) that the actual amount of 
capital in underground financial markets may be considerably 
smaller.  End Comment. 
 
¶7.  (SBU) Cai said the Wenzhou PBOC has chosen over 600 sites in 
rural and suburban areas from which it monitors local lending 
rates and the flow of private capital, including to which 
industries the capital is flowing.  The data is collected by the 
PBOC's own local staff based in different counties across 
Wenzhou.  From this data, he estimates current monthly 
(non-annualized) private interest rates to be roughly 3 to 4 
percent, though there are reports of monthly interest rates 
reaching 8 percent or higher for some very short term loans. 
 
Small-Sum Loan Companies only Temporary Solution 
--------------------------------------------- --- 
 
¶8.  (SBU) In May 2008, the CBRC and PBOC jointly promulgated the 
"Guiding Opinions on the Pilot Operation of Small-Sum Loan 
Companies" delegating authority to provincial governments to 
issue guidelines and grant licenses to small-sum loan companies, 
with the express purpose of helping SMEs find financing. 
Zhejiang Province is the first province to have issued 
regulations and to begin granting licenses.  Cai said this is 
part of the government's effort to develop financial 
intermediary markets, helping to connect entrepreneurs and 
investors, and increasing the overall efficiency of China's 
capital markets. 
 
¶9.  (SBU) Sixteen licenses already have been granted in Wenzhou 
under heavy competition.  In order to obtain one of these 
licenses (as established by Zhejiang regulators), companies must 
have more than 50 million RMB in net assets and have recorded 
profits for three straight years with total profits exceeding 15 
million RMB.  In less developed areas the restrictions are 
slightly relaxed, requiring only 20 million RMB of net assets 
and 6 million RMB of total profit.  Asset liability ratios are 
not allowed to exceed 70 percent.  Cai expects that interest 
rates for small-sum loan companies will not be over four times 
the benchmark interest rate determined by the PBOC. 
 
¶10.  (SBU) Cai and Wenzhou BOFTEC's Pan expressed skepticism 
over the efficacy of these small-sum loan companies in easing 
the overall credit-tight environment.  Pan noted the companies 
can only raise capital from investors, ensuring they would 
remain secondary to commercial banks which raise capital through 
deposits as well as from investors.  Cai likewise did not see a 
prominent role for small-sum loan companies in China's financial 
system, noting they would likely fade even further into the 
 
SHANGHAI 00000342  003 OF 003 
 
 
background when credit policies are relaxed at some future date. 
 He hopes such efforts nevertheless will help bring capital out 
of the underground market. 
 
Comment 
------- 
 
¶11.  (SBU) One unintended consequence of China's credit 
tightening policies is the disproportionate burden placed on 
SMEs.  Underground financing has arisen to relieve some of the 
burden, but estimates of its true extent are few and of 
questionable accuracy.  PBOC/Wenzhou Cai's estimate that 10 
percent of financing in Wenzhou comes from underground lending 
casts doubt on other estimates that suggest underground lending 
nationally accounts for 25 to 30 percent.  This also raises 
questions over the ability of the underground financial system 
to meet the financing needs of struggling SMEs.  Small-sum loan 
companies have been discussed as another possible solution for 
helping resolve financing difficulties faced by SMEs, though 
interlocutors did not see them as having much effect beyond 
temporarily improving intermediary financial markets.  This 
suggests the government is still unwilling to allow any serious 
alternative to the major state-owned banks, even at the expense 
of the most productive actors in the economy. 
JARRETT