The flow of a large amount of private capital to the housing market resulted in Wenzhou's housing bubble expanding to a dangerous extent. With contractions in external demand and the enormous changes that have occurred in the domestic financial situation in 2010, Wenzhou's bulging housing bubble, which was founded on the booming underground credit market, finally burst.
Wenzhou's rampant underground credit market has not only resulted in the collapse of its underground financial bubble, it has also had a severe impact on the real economy. Much worse, the underground financial crisis now runs the risk of being transmitted to the official financial system. It poses a serious threat to the financial markets in other regions and could even trigger a systematic risk to the whole national financial system if it is not checked.
Wenzhou's experimental financial reforms could legalize the city's underground financial sector, permit the registration of its private credit agencies as legitimate ones that can engage in private lending, and open up more domestic and overseas channels for investment. Legalizing Wenzhou's underground credit agencies and allowing their credit transactions under the guidelines of government policies will help ease to a large extent the financing difficulties local SMEs now face.
However, to register as a private lending agency, private capital has to undertake comparatively high financial risks. In the absence of a proportional risk pricing power, the majority of private capital will have little willingness to enter the market, as indicated by the establishment of only 28 small-amount lenders by the end of June, far less than the 100 the local government plans to set up by the end of 2013. The reluctance to set up such private lenders has directly caused a large portion of nongovernmental funds to remain outside the government's financial monitoring.
With the financial reforms the government can also explore the establishment of more financial markets, institutions and products to increase investment channels for the enormous amount of underground capital that exists. However, at a time when a unified national financial market has not yet been established, local financial markets, institutions and products like the ones Wenzhou is attempting to set up lack enough attractiveness for private investment.
The author is a researcher with the Institute of Finance and Banking under the Chinese Academy of Social Sciences.
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