A self-employed businessman (right) in Lingyang township of Rizhao city, East China's Shandong province, counts his micro loan from the Lingyang rural credit cooperative. [China Daily]

    Microcredit lenders, once the quaint peripheral players in China's mammoth financial system, are emerging from the shadows of the State-owned banks as white knights to thousands of small, cash-strapped manufacturers around the nation.

    The spate of bankruptcies in the manufacturing sector, particularly in the Pearl River Delta region, has prompted the government to act by selectively relaxing credit controls three times in the past two months.

    But many economists and financial experts remain doubtful as to whether the large commercial banks would be prepared to spare their administrative and marketing resources for the much less cost-effective business of making micro loans. In a recent forum in Beijing, officials and experts emphasized the importance of promoting private financing as a major source of funding to small businesses.

    "It is time to lift excessive regulatory restrictions on private financing, which could help boost the dynamics of enterprises as well as improve the capital efficiency of the financial industry as a whole," Wu Xiaoling, vice-chairwoman of the Financial and Economic Committee of the National People's Congress, said at a financial forum in mid-September.

    Xu Xiaonian, a professor of economics and finance at the China Europe International Business School, said at the same forum: "It is urgent for us to recognize the increasing importance of commercial credit, which can help improve financing efficiency to help companies grow."

    Their concerns were apparently shared by the government. In mid-August, it introduced new incentives to encourage microcredit lenders to provide more loans to small companies engaging in labor-intensive manufacturing activities and to retrenched workers to finance start-up businesses. In addition, the central bank has allowed qualified microcredit lenders to source funds in the inter-bank money market for on-lending to their customers.

    The projected growth of the microcredit business will have a far reaching impact on China's financial markets by channeling part of the huge deposit base of the banking system to finance the growth of the vibrant private sector, which, unlike the staid State-owned sector, is made up primarily of many highly competitive and adaptable enterprises. Lenders will have to learn to assess the credit worthiness of this class of borrowers by their cash flow and growth potential rather than by asset value and government guarantee.

    Microcredit is nothing new in China. In 2005, the People's Bank of China, the central bank, initiated a pilot scheme to develop microcredit firms in different provinces, with the original intention of financing agricultural production and supporting the livelihoods of the rural poor rather than the manufacturing industry. In recent months, microcredit loans have been directed toward small businesses that have taken a hit under the tightening monetary policy adopted to battle inflation.

    The establishment of the first two microcredit firms, Shanxi Rishenglong Microcredit Co and Shanxi Jinyuantai Microcredit Co on December 27, 2005, was widely seen as the beginning of justification for private financing, whose development had been for a long time stifled as its status was not recognized. Since then, both decision makers and businesses have gradually accepted private financing as an alternative source of funding to substitute traditional bank loans.

    A year later, with central bank support, another five microcredit firms were established in the provinces of Shaanxi, Sichuan, Guizhou and in the Inner Mongolian autonomous region.

    Since the first batch of seven such lenders was inaugurated, microcredit firms have expanded to more provinces.

    By the end of March, a total of 24 microcredit firms, with a combined registered capital of 1.05 billion yuan ($153.33 million), had been set up in the Ningxia Hui Autonomous Region. Meanwhile, in Inner Mongolia, there are now 13 microcredit firms with combined registered capital of 670 million yuan.

    Despite the small size of micro loans compared with commercial bank loans, microcredit lenders have given out a considerable total sum to fund a large number of companies, especially small businesses, which tend to find it particularly difficult to obtain bank loans. The first seven microcredit firms had outstanding loans of 470 million yuan as of March, while the banking system's total was 800 billion yuan in the first quarter, central bank statistics show.

    The seven microcredit lenders also have very low non-performing loans ratios. Latest figures show that their overdue loans account for 0.63 percent of their total outstanding loans.

    Take Shanxi Rishenglong Microcredit Co for example. The lender's rate of default on interest payments in the past three years averaged below 1 percent of all outstanding loans. By the end of 2007, the company's interest income totaled 5.81 million yuan and its profit was 4.69 million yuan.

    Experts say the sense of urgency that small businesses' current financing problems evoked should speed up financial reforms and innovation to restructure the financial sector.

    "People are becoming more aware of the fact that private capital is playing an increasingly important role in funding the growth of small enterprises, and more private capital is being pumped into small enterprises in the form of microcredit to help ease their capital shortage," Zhou Dewen, president of Wenzhou's council for the development and promotion of small and medium-sized enterprises, says.

    Zhou adds that more than 270 loan guarantee agencies have been established in Wenzhou to help small businesses obtain loans. There were only two such loan guarantee agencies in 2000.

    Policymakers, at the same time, are recognizing the necessity of developing diversified financial institutions to support small business.

    On May 4, the central bank and the China Banking Regulatory Commission published a joint statement encouraging more microcredit firms to be established in different provinces to help finance small businesses - provided the provincial local government could serve as guarantor of the micro loans and supervise the operation of the microcredit firms.

    The removal of restrictions allowing qualified microcredit firms to borrow in the inter-bank money market has greatly strengthened their financial capacity to make loans. Previously, microcredit lenders had no other funding source but their own shareholders' capital.

    After the May statement was issued, Zhejiang province said it would establish microcredit firms, which are expected to start providing small loans after they get regulatory approval. Other provinces including Guangdong, Jiangsu and Anhui are also preparing to launch microcredit firms.

    Zhou Dewen at the Wenzhou council tells China Business Weekly that in Zhejiang province's Wenzhou, home to the largest number of SMEs in China, 16 new microcredit lenders are being established.

    Huo Xuewen, deputy director of the Beijing municipal commission for development and reform, said in late July that the capital is working on regulations for microcredit companies and will introduce several small lenders under a pilot scheme before the end of the year.

    In mid-August, the government introduced new incentives to encourage the establishment of more small lenders to provide microcredit loans to labor-intensive small firms and retrenched workers starting new businesses.

    In a joint statement, the central bank, the Ministry of Finance and the Ministry of Human Resources and Social Security, said microcredit lenders could now raise the lending rate by up to 3 percentage points more than the benchmark rate for loans granted after January 1 to laid-off workers starting new businesses.

    The new measures also raised the maximum loan to laid-off workers from 20,000 to 50,000 yuan and the maximum loan for qualified small firms from 1 million to 2 million yuan.

    All of these measures are seen as part of the central government's efforts to provide additional capital to encourage the growth of SMEs and create more jobs.

    Economists and financial experts agree on the enormous growth potential of microcredit firms, but say the lenders' ability to source low-cost capital will be the key to their sustained growth.