The Wenzhou Experiment: Reviving Traditional Lending Practices to Address New Business Challenges

Wenzhou is an eastern port city, about 300 miles south of Shanghai, driven largely by local, family-owned firms. When the ripples of the 2008 global financial crises came ashore, traditional funding dried up, and access to relief needed new attention. 

The Chinese government responded in a way not unlike other governments. It plowed money into formal financial channels -- especially state-owned companies -- seeking to stimulate the economy. While the effort helped boost the government-funded businesses, it also made life tougher for small-business owners. 

More than half of the small businesses throughout China -- according to a new report from the Economic Freedom Network Asia, a nonprofit network of researchers and market economists -- rely for funding upon a system of informal lending among individuals and businesses. 

This informal practice happens outside of the official financially regulated world of loans and interest. By and large, these types of lending are legal, but this financial mechanism also proved very vulnerable to the economic troubles. 

The new report details how certain crucial informal lending systems in Wenzhou buckled and then fell apart in recent years. The government told business owners they'd have to comply with the formal system if they wanted subsidies. But that may be about to change. In Wenzhou, this past spring, China instituted its Comprehensive Pilot Financial Reform Zone.

The Zone amounts to a loose-regulation hybrid, one in which small-business owners can still move personal capital back and forth, but under a more-monitored, semi-institutional model. 

Some elements of the plan include: 

• New Types of Financial Institutions: China wants to set up rural banks, credit companies and funding associations in Wenzhou to take the place of the more or less unmanaged old-style informal funding practices.
• Better Bank-to-Small-Business Channels: The government is pushing established banks to create credit units specifically geared toward small businesses.
• Early Warning System: Out of this new monitoring, and with the new government involvement, Chinese officials hope that better detection will emerge, when it comes to any future problems in the informal funding environment. 

The report says that China tends to try out new programs in one region at one time. If it works, the pilot program will likely then be replicated. In that case, given the pervasive nature of informal funding, the Wenzhou experiment stands to go countrywide. 

Since the pilot program was instituted only in the spring 2012, how well and how quickly it works will become clear in the coming months. 

What does it mean for small businesses, if it succeeds? It stands to protect them from further damage should the Chinese informal-lending market wobble or fall apart in the future.

Rather than restricting entrepreneurs, subjecting them to the financial pressures of total conformity, when it comes to funding, small-business owners may get a chance to participate in a re-visioning of their older, informal ways.