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When formal finance meets the informal: the case of Wenzhou

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Abstract

We examine the causes of the financial crisis of 2011 in the Chinese city of Wenzhou. While the crisis of 2011 has been attributed to weaknesses in the system of informal finance, including predatory interest rates, we suggest that the roots of the failure lay in the way that the formal and informal systems became intertwined in the period following the global financial crisis of 2008 and the expansionary monetary policy initiated by the Chinese authorities to counter its effects. We explore the effects of the over-supply of formal credit in this period and the encouragement of group lending, a practice relatively unknown prior to 2008, and which magnified the effects of the crisis. We suggest that the lesson to draw from Wenzhou is not that informal finance is inherently more instable or inefficient than formal finance, but that encounters between formal and informal finance can trigger instabilities in both.

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Notes

  1. Schumpeter [39].

  2. King and Levine [26], Rajan and Zingales [38], Guiso et al. [23] and Beck et al. [6].

  3. Chen [10] and Allen et al. [3].

  4. Tsai [48].

  5. Allen et al. [2, 4].

  6. Greif [21].

  7. Geertz [19], Ardener [5] and Bouman [7].

  8. Deakin et al. [15].

  9. Stinchcombe [47].

  10. Shi [44] and Zheng et al. [57].

  11. Allen et al. [1, 2].

  12. Stiglitz [46] and Allen et al. [4].

  13. Gupta and Chaudhuri [24], Guirkinger [22], Ngalawa and Viegi [31], Madestem [29] and Allen et al. [4].

  14. A prefectural-level city, formerly known as province-administrated city from 1949 to 1983, is an administrative division of China, ranking below a province and above a county in China's administrative structure. Prefectural-level cities form the second level of the administrative structure.

  15. Forster [18].

  16. Qin et al. [37, p. 22].

  17. Forster [18] and Bramall [8].

  18. Qin et al. [37, p. 22].

  19. On the Wenzhou model and the development of China’s private sector, see e.g. Parris [32], Fei [17] and Sonobe et al. [45].

  20. Liu [28, p. 298].

  21. Shi and Ye [43, p. 64].

  22. Qian [35].

  23. Tsai [49, p. 16].

  24. People’s Bank of China [34].

  25. Interview with Judge, September (2017).

  26. Interview with manufacturing executive, December 2018.

  27. Tsai [48].

  28. Zhao and Koh [55].

  29. People’s Bank of China [34].

  30. Zhejiang Statistical Yearbook [56].

  31. Xie et al. [51] and Shao [40].

  32. Chen [11].

  33. Zheng et al. [57], drawing on the analysis in Shi [44].

  34. McKinnon [30] and Shaw [41].

  35. Giovannini and de Melo [20].

  36. It should be noted that in August 2019, the PBOC made a further step to liberalize the interest rate by promoting the Loan Prime Rate (LPR). The PBOC instructed banks to rework, between March and August 2020, all floating-rate loan contracts to refer to the 1- and 5-year LPRs instead of the previous benchmark loan rates. However, this reform does not affect our analysis which refers to the years 2008–2011.

  37. Allen et al. [2].

  38. Brandt et al. [9].

  39. People’s Bank of China [33].

  40. Interview with judge, September (2017).

  41. Ye et al. [53].

  42. Du [16, pp. 33–34].

  43. Stiglitz [46].

  44. Zhang [54].

  45. Shen [42].

  46. Haldar and Stiglitz [25].

  47. Zhang [54].

  48. Li [27].

  49. Interview with judge, September (2017).

  50. Interview with judge, September (2017).

  51. Ye [52, p. 67].

  52. A criminal law amendment was passed by the People’s Congress on 29 August 2015 to remove the death penalty for illegal fundraising. This amendment came after the period to which our discussion in this paper relates.

  53. Qin et al. [36, p. 5].

  54. Chen et al. [12, p. 165].

  55. Interview with manufacturing executive, December 2018.

  56. China Securities Journal [13].

  57. Wen [50].

  58. Credit Suisse [14].

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Acknowledgements

This research is supported by the Economic and Social Research Council (ESRC) Newton Fund and National Science Foundation of China (ES/P004091/1). We like to thank Zhejiang Provisional Court and Wenzhou Intermediate Court for their kind assistance with our interviews. We also like to thank Joanna Gray, Andrew Johnston, Gerard McCormick, Xian Huang, Hengzhu Zhang and Liuchuang Yuan for their comments.

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  1. School of Law, University of Sheffield, Bartolome House, Winter Street, Sheffield, S37ND, UK

    Ding Chen

  2. School of Law, Centre for Business Research, University of Cambridge, Trumpington Street, Cambridge, CB2 1AG, UK

    Simon Deakin

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Chen, D., Deakin, S. When formal finance meets the informal: the case of Wenzhou. J Bank Regul 22, 208–218 (2021). https://doi.org/10.1057/s41261-020-00139-9

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