Wenzhou, an entrepreneurial hub in East China's Zhejiang Province and a pilot area for financial reform in China, unveiled Friday a regulation to legalize underground lending that previously led to a local financial crisis.

It is the first local regulation in China to turn grey-market lending into acceptable credit to support cash-thirsty small firms while reducing financial risks.

Lawmakers of Zhejiang Province passed the bill on Friday, and the new law will be effective from March 1, 2014, an official from the Standing Committee of the Zhejiang Provincial People's Congress confirmed with the Global Times on Friday.

The regulation legalizes private channels for the 400,000 local small firms to get finance in Wenzhou and also helps individual investors to gain investment returns, Zhou Dewen, president of the Wenzhou Council for the Promotion of Small and Medium-sized Enterprises, told the Global Times on Friday.

"The new regulation will mend the inefficiencies of financial institutions in Wenzhou which is the hub of small firms and the most active center of private financing in China," Zhou said.

Private financing is defined by the regulation as financing activities that take place between individuals and non-financial institutions and organizations through private lending, bonds issuing, or private placement.

The law is good news as it benefits both businesses and the investors, Lin Axin, a Wenzhou entrepreneur who runs an investment company, told the Global Times on Friday.

Under the law investors and borrowers are obliged to file with the local financial authorities under certain circumstances.

Any single loan of over 3 million yuan ($489,396) or multiple loans that reach 10 million yuan will have to be filed with local financial authorities, the regulation says.

Firms are allowed to issue bonds to a maximum 200 investors over a period of one year or longer and the coupon rate capped 3 times the official benchmark lending rate, as long as the firm's debt-to-asset ratio is less than 70 percent after financing, said the regulation.

The government will review private financing to check the money is legal, and they will have to share the information with the industrial and commercial administration, tax bureau and public security bureau to prevent potential fraud and protect all parties' interests, Zhou said.

Violation of the regulations will be subject to fines ranging from 10,000 yuan up to 500,000 yuan.

Unlike the preliminary draft, the regulation did not specify the ceiling of the rate in a private lending, but instead says "the lending rate will be set based on negotiations between borrower and lender, but it cannot violate the relevant regulations of the country."

Currently, private lending is capped at four times the benchmark official lending rate. Private financing thrived in Wenzhou and many other places in China as small firms often have no access to bank loans and State-dominant banks prefer lending to large State-owned enterprises backed by local government credit.

The regulation in Wenzhou is significant because it sets a good example for other regions where underground banking is active to follow, Zhou said.

Crisis broke out in 2011 when local private lending went out of control as some annualized interest rates even reached 100 percent, and many entrepreneurs fled the country unable to repay high interest loans.

Private financing developed extremely fast following China's 4 trillion yuan stimulus package in 2009 and 2010, and became rampant when the country adopted a tightening monetary policy in 2011 when many small businesses turned to private lending and underground banking to raise money and promised high returns.

Lured by interest rates much higher than the bank deposit rate, and partly due to a lack of good investment products, individual investors were enthusiastic in lending out personal savings in order to get high returns.

Amid economic downturn, facing weak demand and surging labor cost, however, many businesses especially hard-hit small businesses went bankrupt leading to heavy losses for hundreds of thousands of individual investors.

In March 2012, the State Council approved Wenzhou as the pilot city of a financial reform, through which it hopes to tame the underground lending market and act as a laboratory for national implementation.

Private bank gets first ever government license

China's banking regulator has approved the country's first privately held bank, as part of reforms intended to open the country's financial sector to private investors, Shenzhen-based Securities Times reported on Friday.

Shandong Yucheng Rural Commercial Bank got the approval from China Banking Regulatory Commission (CBRC) on Wednesday, with its largest shareholder Shenzhen-listed Baolingbao Biology Co, according to a statement filed with Shenzhen Stock Exchange on Friday.

Baolingbao, a private firm in Shandong, is the largest shareholder with 8.21 percent stake of the rural commercial bank, and four other major shareholders are also private firms. Baolingbao's share price soared Friday by almost 10 percent.

China will allow qualified private investors to set up small and medium-sized financial institutions as an effort to open up the State-dominant sector, according to a recent road map that charts the future course of the world's second largest economy.

More than 20 listed companies including air conditioner maker Gree Electric Appliances Inc, home appliance retailer Suning, and personal computer maker Lenovo have expressed interest in the banking business.

The approval of the bank marks a step forward for policy implementation, Zhang Taowei, a finance professor at Tsinghua University, told the Global Times on Friday.

Global Times