Building a Banking System out of Loose Sand: a Policy Perspective on Informal Finance in ChinaThus there are no intrinsic reasons why the volume of capital cannot be increased until it ceases to be scarce, so that the functionless investor will no longer receive a bonus; we must aim for an economic system which allows the intelligence and executive skill of the entrepreneur and the financier to be harnessed to the service of the community on the most reasonable terms of reward. John Maynard Keynes, The General Theory of Employment, Interest, and MoneyIntroductionIn a casual analysis, the struggles faced by the Chinese financial sector can be thoroughly perplexing. It appears to be a paradox that the worlds fastest growing economy also houses some of the worlds most unprofitable banks. The inefficiency of Chinas banks can be altogether staggering: the total amount of bad loans outstanding currently stands at USD 268.3 billion, or 10.54% of GDP. In total, it is estimated that over 50% of the loans extended by Chinese banks in the reform era have been non-performing[footnoteRef:2]. The cause for poor performance is straightforward a vast majority of the loans[footnoteRef:3] extended by the banking system in China are issued to State Owned Enterprises (SOEs), which are on average much less efficient than Chinas private sector[footnoteRef:4]. It is astonishing just how unprofitable the companies that receive bank loans in China are compared to their private counterparts: on average, a company receiving a bank loan in China has an ROE of negative 32.81% over the following two years[footnoteRef:5]. In sum, these statistics imply not only a misallocation of capital within the Chinese financial system, but also a sizeable destruction of value. [2: For a comparative perspective, refer to Exhibit 1: Brandt, Loren and Thomas G. Rawski. China's Great Economic Transformation. London: Cambridge University Press , 2008: pp. 521-525.] [3: 84% of loans extended by Chinas big four banks go into other SOEs (personal loans mostly for real estate development comprise a further 14%): Liu, Chen Xiang. "SME Financing in China." Economics Working Papers, University of Paris (2007): p. 6] [4: It is estimated that the capital intensity of Chinas SOEs lies at 50% of output, a considerable figure: Consulate General of Switzerland in Shanghai. China's Banking Sector with a Focus on Shanghai. Survey. Shanghai: Consulate General of Switzerland in Shanghai, 2007.] [5: Bailey, Warren B., Huang Wei and Zhishu Yang. "Bank Loans with Chinese Characteristics: Inside Debt, Firm Quality, and Market Response." 2008: p. 45]

However, the unfortunate state of the banking sector in China only further confounds the puzzle of Chinas economic miracle. The literature on the importance of savings mobilization and, by extension, financial intermediation to economic growth is widespread[footnoteRef:6]. Yet while less than 1% of total bank loans are extended to the privately owned enterprises[footnoteRef:7], this sector continues to be the primary driver of GDP growth in China[footnoteRef:8]. And so the question remains how has this growth been financed? [6: For more information with regards to the importance of savings mobilization on economic growth, refer to Amaral and Quinton (2007), Minsky (1967), and Stiglitz and Weiss (1981)] [7: In total, .66% of loans extended by the Chinese banking sector go to private and individual enterprises: Tsai, Kellee S. "Congressional Testimony on China's Financial System." US-China Economic and Security Review Commission. Washington D.C.: USCC, 2006: p. 1. ] [8: SMEs, which comprise 98% of the private sector, are responsible for 65% of Chinas economic growth, 75% of industrial output created since 1990, 80% of employment, and 69% of exports: Jia, Chen. "Development of Chinese Small to Medium-sized enterprises." Journal of Small Business and Enterprise Development (2006): pp. 140 - 145]

The short answer is that in the absence of formalized finance, the capital needs of the private sector in China have been satiated by an informal financial system which has proven to be vastly more efficient than the state-owned banks[footnoteRef:9]. This informal financial system, while often criticized by the media, has nonetheless supplied in excess of 75% of private sector credit[footnoteRef:10]. The fact that these localized, informal financing mechanisms have developed to the point whereby they finance a large portion of the Chinas growth stands as a remarkable testament to the adaptiveness and ingenuity of the Chinese people. Indeed, informal finance in China is as diverse as the nation itself, ranging from simple interpersonal lending within a guanxi network to full service illegal private banking institutions. [9: Overhead costs of the formal Chinese banking system stands at 12.2% of assets: Allen, Franklin, Jun Qian and Meijun Qian. "Law, Finance, and Economic Growth in China." Journal of Financial Economics (2005): 57-116: p.71.] [10: Tsai (2006): p. 2]

Unfortunately, the fact that these financing mechanisms are underground implies that the central government has very little control over them. In a formalized financial system, the banking sector is structured hierarchically (see: Exhibit 2). That is, the central bank, who is the sole dealer of central bank bills[footnoteRef:11], has considerable influence over the interbank money market overnight interbank interest rates are determined largely by the supply of central bank bills in circulation (which is continuously adjusted by the central bank to meet a target interest rate). This interbank rate determines how much excess liquidity is in the banking system (i.e. if the central bank sets interest rates low, the banks will have a much larger lending capacity), which in turn indirectly sets all of the interest rates in the economy. By manipulating interest rates, a central bank is therefore able to fine tune the overall investment (lower rates spur corporate investment) and consumption (lower rates disincentives marginal saving) in the economy, smoothing the ups and downs of the business cycle. [11: Central bank bills are short term discount notes perceived by the market to be risk free (indeed, they are backed by the full faith and power of printing presses of the U.S. Treasury). These notes are the primary collateral used by banks in overnight Repo transactions, which are used to mitigate short term funding shortfalls. ]

Chinas informal financial system is, however, marked by decentralization and localized institutions (see: Exhibit 3). The flows within these local systems cannot and are not[footnoteRef:12] influenced by the Peoples Bank of Chinas (Chinas central bank, hereafter PBoC ) centrally implemented monetary policy. This inability to control the underground financial system understandably terrifies policymakers in Beijing, who tend to view such institutions not only as an economic threat but also as usurious and a threat to social stability[footnoteRef:13]. This has elicited a hard-line view of informal finance by the State Council, which in 1998 explicitly banned informal financial institutions and outlined how such financing activities should be shut down[footnoteRef:14]. The voice of the communist party, the Renmin Ribao, reported[footnoteRef:15]: [12: A notable exception is the management of the RMB exchange rate by SAFE in export-dominated areas.] [13: To illustrate usurious activity, illegal lenders often charge interest rates much higher than the official rates set by Chinas big four banks (sometimes as high as five to six percent per month). For an example of how informal finance can threaten social stability, refer to the growth of taihui (escalating rotating credit association) in Wenzhou in 1986, which devolved into Ponzi schemes: Bradsher, Keith. "China's Informal Lending Poses Risks to Its Banks." New York Times 9 November 2004.] [14: Document is entitled Provisions on the Cancellation of Illegal Financial Institutions and Activities.] [15: Tsai, Kelly S. Back Alley Banking. Ithica: Cornell University Press, 2002: p. 1.]

We must severely attack all actions in the financial arena that are illegal or in the violation of regulations. We must guarantee that all financial laws, regulations, and rules are implemented thoroughly. We must emphasize the prohibitions against banks using high interest rates to monopolize deposits, illegal fund-raising in society, and haphazard financial activities.Yet despite the central governments aversion to informal finance, crackdowns on illegal lending are done sporadically, usually on an ad hoc basis. The reason for this is that while the central government is decidedly opposed to the propagation of informal finance, many local governments (especially in the southern coastal regions) understand the imperative need for their existence and turn a benevolent blind eye to the practice. And yet, as economic reform has progressed, Beijings technocrats have attempted to simultaneously fashion Western-style financial institutions (of which progress is steadily being made) as well as mitigate the usage of underground financial institutions. This paper will argue that the informal financial system in China is much more vital to the countrys growth, and poses much less of a social risk, than is commonly understood. Furthermore, this paper will make a case that Chinas existing informal financial institutions are an invaluable untapped resource for the nations ongoing financial reform rather than build new institutions in order to mimic a Western-style financial system, Beijing should consider formalizing and regulating the institutions that Chinas private sector already uses. The conclusion outlines, from a policy perspective, some approaches Chinas reformers could take to formalize a selection of certain informal institutions. To this end, it would be a grave mistake to attempt to eradicate informal finance at this point in Chinas development. Investment-Motivated SavingsEconomists have frequently inquired as to the causes of Chinas historically high savings rate[footnoteRef:16]. It is incongruent with conventional economic theory for a developing country such as China, still poverty stricken in areas, to produce such a large imbalance between aggregate production and aggregate investment and consumption. In analyzing Chinas savings rate, it is first vital to separate personal savings rates from currency effects. It is important to remember that the large headline figure of 50% also implicitly includes Chinas trade surplus: when viewed in isolation, an economy that exports more than it imports is, technically, producing (via exports) more than it consumes (via imports). Of course, the causes of Chinas trade surplus are widely disputed and outside of the scope of this paper[footnoteRef:17]. Once this effect is adjusted for however, the isolated personal savings rate still stands at an impressive 28.3% of disposable income[footnoteRef:18]. Nonetheless, this still leaves the question unanswered: why is the savings rate so high? [16: The aggregate savings rate of the Chinese economy stands at 50%, a staggering figure. No major economy has documented a savings rate so high since the Stalinist U.S.S.R: Fallows, James. "The $1.4 Trillion Question." The Atlantic Monthly January 2008: p. 2. ] [17: The two most oft cited causes are: firstly, an overly weak RMB and secondly, relative advantages due to the realization of location economies of production. While either or both of these factors could have caused Chinas trade imbalance, my preferred theory is one espoused by financial economist and China expert Michael Pettis. His theory is that a monetary trap is created whereby large current account surpluses cause domestic monetary expansion, which spurs investment in export-oriented industries. The increased production of goods meant for export further widens the current account surplus, again increasing the domestic money supply, and so on. The trap could only be broken if investment is incentivized to finance imports rather than exports, or if the RMB becomes fully convertible.] [18: He, Xinhua et al. "Understanding High Savings Rate in China." China & World Economy (2007): p. 2]

The most frequently cited view is that the high savings is due to the uncertainly about the future that SOE workers feel due to the widespread privatization of Chinas SOEs[footnoteRef:19] and the layoffs that result. Unfortunately, this hypothesis fails to take into account that there has also been a high savings rate in rural areas in which workers are predominantly employed in agriculture, not loss-making SOEs (in addition to this dynamic, the uncertainly hypothesis neglects the fact that only roughly 20% of Chinas citizens are employed in state owned enterprises). Another view is the so-called precautionary savings hypothesis, which posits that Chinas lack of an adequate social safety net causes a rise in household savings in the event of a medical or some other sort of emergency. But in a comparative context, this view is also inaccurate: after all, comprehensive and well-funded social safety nets in developing countries are the exception rather than the norm[footnoteRef:20]. [19: Woo, Wing Thye. "The Structural Obstacles to Macroeconomic Control in China." The International Journal of Applied Economics (2005): 1-26: pp. 9-11.] [20: For example, Latin Americas average personal savings rate has averaged around 4% over the past decade; African countries have posted even lower personal savings rates. It would be a stretch to assume that the social safety nets in these locations were many orders of magnitude better than Chinas: EarthTrends. Country Profile: Brazil. Washington D.C.: World Resources Institute, 2003.]

It is possible that the reality is less confounding: it is well documented that the primary motivation behind saving is the desire to invest[footnoteRef:21]. Indeed, to quote Jeffrey Williamson, an economic historian: [the historical record of Western Europe and North America shows that] investment demand seems to have been the driving force behind private saving and accumulation, past and present[footnoteRef:22]. At first glance a hypothesis of investment-motivated savings may seem odd to posit because of the extremely low rates offered to savers at Chinas formal banks with such low interest rates, there would seem to be little incentive for a Chinese household to hold large deposits. [21: Woo, Wing Thye and Liang-Yn Liu. "Savings Behavior Under Imperfect Financial Markets and the Current Account Consequences." The Economic Journal (1994): 512-527.] [22: Woo (2005), p. 10.]

Yet in the absence of formalize finance, it is important to remember the local reality is that savers, investors, and potential entrepreneurs are not three separate and disparate groups but are intricately related within their social network. To illustrate, suppose a family decides that it would like to open up a light factory to do so, because of Chinas lack of availability of both personal credit and venture debt, the family would be required to save up and pay in the startup capital. In other words, the familys venture would largely be self-financed, and self-financing by definition implies an accumulation of savings in advance.This hypothesis can further illuminate the nature of the savings and investment in China. Refer to Exhibit 4: during the 1980s, investment in urban enterprise was miniscule compared to that in rural areas and that of Chinas SOEs similarly, the savings rate for non-rural workers was never above 13%. As the urban savings rate has steadily increased since 1992, so has the share of urban investment. This contrasts against rural and SOE investment, which has remained roughly constant as a percentage of GDP. Above all, what is remarkable about the tandem growth in urban savings and investment is that the savings have been mobilized completely independent of a banking system. It is vital, therefore, to understand the mechanism by which these savings are converted into investment and where this investment precisely comes from (to see the breakdown of financing undertaken by private Chinese companies, refer to Exhibit 5). Of surveyed Chinese entrepreneurs, the top five sources for start-up capital were: family savings, close friends, suppliers, extended family, and colleagues[footnoteRef:23]. Notice that while accumulated family savings was the top source, the remainder comprises of loans and investment from members of the entrepreneurs guanxi network. These sources are rarely institutionalized, which implies that these local lenders would similarly be required to accumulate cash savings beforehand. [23: Pistrui, David, et al. "Entrepreneurship in China:Characteristics, Attributes, and Family Forces Shaping the Emerging Private Sector." Family Business Review (2004): 141-152: p. 150.]

Informal Financing MechanismsInterpersonal BorrowingPerhaps the simplest and most common mechanism in Chinas informal financial system is interpersonal borrowing within ones guanxi network. In excess of 60% of Chinese entrepreneurs report that have used interpersonal borrowing in order to meet financing needs[footnoteRef:24]. This practice of borrowing and lending among friends, colleagues, and relatives has a long history in China, beginning in the Western Zhou dynasty[footnoteRef:25]. The terms of these loans can vary wildly: they can be principal-only (generally between friends and relatives), or carry significant interest charges (typically between entrepreneurs). Also, different parts of China have different cultural norms with regards to interpersonal lending: loans in the south of China are more commercial, with higher interest rates (2.80% versus .83%[footnoteRef:26]), a shorter maturity (4.5 months versus 11.2 months), and a larger face value (on average 2.28 times larger in the south). In addition, in Chinas coastal south, entrepreneurs are far more likely to charge interest on their loans than those in the industrial north: 28% of lenders had charged interest in the south, compared with 7% in the north[footnoteRef:27]. [24: Tsai (2002): p. 57] [25: Hu, Biliang. Informal institutions and rural development in China. Chicago: Routledge, 2007: p.102.] [26: Respectively, 39.29% and 10.23% annualized.] [27: Tsai (2002): p. 55-59.]

Rotating Credit Associations (Hui)Of course, while widespread, interpersonal borrowing is only a small segment of Chinas informal financial system there are far more institutionalized alternatives. One popular financing mechanism is a rotating credit association (usually consisting of about 15 people) called a hui. With a history dating back to Tang dynasty China, a basic hui (also termed lunhui) is a simple interest free scheme whereby each member contributes a fixed payment a collective pot. In this basic hui, the member that receives the pot rotates every meeting, which would traditionally either be monthly or semiannually[footnoteRef:28]. The advantage of the hui structure over an individual accumulating cash savings is obvious hui allow for the pot recipient to immediately collect a large sum of cash with simply by paying smaller intermittent payments over the course of the rotation. In essence, for the first recipient, the rotating association is structurally identical to taking out a loan. Of course, if a hui participant is last in the rotation, the cash flows coming from the hui would be exactly the same as if one had simply saved the periodic payments. [28: Tsai (2002): pp. 25-27]

Over time, the basic lunhui evolved to a diverse array of different structures, of which the yaohui[footnoteRef:29] and the biaohui are most popular. Originating from Guangdong, the Biaohui is a clever and fascinating structure for a rotating credit association (in the locations where hui are most prominent, the biaohui is the most common type of hui used to finance private businesses). Unlike the other schemes, in the biaohui interest is charged to the recipient of the pot both the recipient and the interest rate is determined by an auction process whereby the participant willing to pay the most interest wins the pot[footnoteRef:30]. Economically, this structure is far more efficient than the others auctions (when designed correctly) are highly informational efficient [footnoteRef:31], and the money is allocated to the individual with the largest expected utility of the pot. [29: In the yaohui, instead of having a fixed rotation, the recipient of the pot is determined by chance (traditionally with a roll of the dice): Tsai (2002): p. 26 ] [30: Tsai (2002): pp. 71-72.] [31: For more information regarding the informational efficiency of auctions, refer to Goeree (2000) and Andersson (2002).]

PawnbrokersWhile certainly not unique to East Asia, another informal financial institution with a long history in China is the pawnbroker, the usage of which dates back Buddhist monasteries in middle of the Six Dynasties. A pawnbroker is a creditor who provides loans, albeit back by collateral (i.e. a good that the broker would be able to take in the event of default). In some ways, it is ironic that pawnbrokers are a widely used informal financing mechanism, due to the abhorrence of the practice by the Chinese Communist Party in the years leading up to 1949. Indeed, while the term pawnbroker conjures images of loan sharks charging usurious interest rates on peasants and stealing family heirlooms, the pawnbrokers in mainland China today service mostly small to medium sized businesses, which account for 97.9% of the industrys clients[footnoteRef:32]. Because pawn brokering is perceived to be a profitable business, many of these institutions are able to secure loans from urban credit cooperatives (comprising about 60% of capital)[footnoteRef:33]. [32: Tsai (2002): pp. 149-150 and Xinhua. "Pawnbroking may help finance China's small firms: adviser." People's Daily 27 January 2005.] [33: Tsai (2006).]

Red-Hat DisguisesLastly, a final source of financing for private Chinese businesses consists of siphoning credit from the official financial sector using so-called red-hat disguises. These disguises can take two forms: first (what is known as a hang-on enterprise), a private company registers as a subsidiary of an SOE. As the SOE receives low interest bank loans from the formal banking sector, the private company pays the SOE to transfer the loan[footnoteRef:34]. Second (referred to as a red-hat enterprise), a company can officially register as a collective enterprise such as a TVE. While a significant portion of informal financing does comes via red-hat disguises[footnoteRef:35], such enterprises were more popular in the 1980s when there was much more political risk in owning a privately owned business. Indeed, it is estimated that in the mid-1980s over 90% of Wenzhous household enterprises were either red-hat or hang-on enterprises[footnoteRef:36]. Unique in comparison to the other informal financing mechanisms, the red-hat disguised companies are influenced by the monetary policy of the PBoC due to their reliance on the flows going to their host SOE (in the case of hang-on enterprises) or the rolling over of bank loans (in the case of the red-hat enterprises). [34: Often, the private company attempts to completely mask their existence within their host SOE in order to evade taxes and regulations which are more stringently enforced on private business than SOEs.] [35: Estimated at 15-25% of all informal financial flows: Tsai (2006): p. 5.] [36: Tsai (2002): p. 130-134.]

ConclusionAs reform progresses, Chinas policymakers should consider formalizing Chinas existing financial institutions rather than simply attempt to duplicate Western-style financial systems. In the end, a countrys financial system should be judged by its function rather than its structure while Chinas formal financial institutions may look strikingly similar to the United States and Europes, it has largely failed the burgeoning Chinese private sector. The financial system in the United States works in the United States because it draws on institutions that function within an American cultural context. China already has a financial system that is congruent with Chinese social norms and functions on a localized level, but the central government insists on its continued illegality.It is difficult to fashion the institutions required to make an effective financial system; some argue that even Japan and South Korea still do not have a financial sector that can efficiently mobilize their nations savings. And while Chinas informal financial sector is obviously in dire need of regulation and bureaucratic supervision, building a banking sector on the financing methods already practiced by Chinese private companies does not have to be outside of the realm of possibility. To help mobilize bank deposits from the lumbering SOEs to more profitable sectors, I strongly feel that SOEs in China should be given the authority to broker loans that is, while the SOE would not have the authority to issue new loans (and thus expand the money supply), they would be allowed to, as they see fit, transfer the capital they received from the formal banks to a private enterprise and make a spread on interest rates (i.e. charging the private company a slightly higher interest rate than the bank charged the SOE). From a local perspective, this makes sense because while an entrepreneur may not have a connection to one of Chinas banks, many SMEs do have connections to local SOEs, as evidenced by the popularity of Red-Hat disguises.Furthermore, pawnbrokers and rotating credit associations (particularly of the bidding variety) are not necessarily incongruent with financial theory. Modern pawnbrokers in China rarely use durable goods as collateral anymore; much more common is lending against real estate and accounts receivable. This is, it should be noted, not materially different than the asset-backed securities market in the United States. Indeed, as the banking sector in the mainland has struggled with creating a domestic mortgage market[footnoteRef:37], it seems strange to not develop the market using Chinas pawnbrokers, which have decades of experience lending against real estate. [37: Chinas mortgage market, once adjusted for GDP, is a similar size as Thailands: Guangdong Provincial People's Congress. "Mortgage industry untapped, says BIS." Guangdong News 13 December 2007. ]

In addition, the biaohui that are widespread throughout the Guangdong, Zhejiang, and Fujian province have a similar potential for formalization. While certain localities in China (e.g. Wenzhou City) have faced periodic crises relating to rampant speculation in hui[footnoteRef:38], the OECD has faced similar situations with regard to investment funds. Simply because a financing vehicle has the capacity to be abused does not necessarily mean the vehicle is without worth it merely necessitates supervision and guidance on the part of regulators. Furthermore, if biaohui were structured so as to allow for the investment from outside investors, it could give the PBoC a mechanism to control the monetary expansion inherent in such an institution (and, if need be, mitigate contraction in the event of a crisis). In conjunction with allowing SOEs to broker loans on a local level, biaohui have to potential to evolve into a far superior financing mechanism for SMEs than bank lending with an investment in just one hui, an investor would be able to get exposure to fifteen different entities, lowering the transaction costs involved in investing in small businesses. In addition, because there is significant social pressure again the default amongst hui members, the monitoring costs (another significant cost of investing in SMEs) would also be greatly alleviated. [38: These practices culminated in the existence of taihui, or escalating associations. These hui are structurally the same as a Ponzi scheme (i.e. new deposits fund the dividends on the original investments); there was word of some hui participants being involved in dozens of taihui in order to fund their involvement in the others. Needless to say, the situation ended badly, and in 1987 the PBoC forced the Wenzhous governments hand and hui were completely outlawed in the city. ]

From both sides of the Pacific, there seems to be a general impression that China needs to and inevitably will move toward a financial system modeled after those in the West. With 80% of Chinas SMEs reporting difficulties obtaining financing[footnoteRef:39] and a sizable destruction of value within the formal financial system, it is an indisputable fact that Chinas financial system needs to vastly improve its allocative efficiency. Yet it is important to understand that while Chinese SMEs do indeed struggle with financing compared to their OECD counterparts, SMEs in most countries face similar difficulties. In the United States, 55% of small businesses report having difficulty securing credit in fact, 44% of all external financing used by American SMEs comes from credit cards[footnoteRef:40]. While the media often reports of usurious interest rates charged by the informal financial system in China, is credit card financing necessarily a preferable alternative? [39: Liu: p. 5.] [40: NSBA. NBSA Small and Medium Sized Business Survey. Survey. Washington D.C.: NSBA, 2008: pp. 16-19.]

To quote John Kenneth Galbraith, the enemy of conventional wisdom is not ideas but the march of events. Ever since reform began in 1978, Chinas growth has confounded developmental economists. The Chinese Communist Party bears little resemblance to the enlightened developmental state, the country has little in the way of institutions that define and protect property rights, and the dominance of SOEs in the financial system would make a public choice theorist irate. And yet, the flexibility and resourcefulness of the Chinese private sector has overcome all of these factors that should supposedly hold it back. The Chinese story has repeatedly redefined how economics views development against this backdrop, should China feel pressured to redefine itself because of how developmental economists view it?Indeed, why should China attempt to eliminate its informal banks, the same institutions that have financed in excess of thirty years of growth? While formalized financial institutions are certainly important for effective implementation of monetary policy, there are less radical courses of action available to Chinas policymakers. Beijing should not necessarily be so quick to replace what is effective with what sounds good.

Works CitedAllen, Franklin, Jun Qian and Meijun Qian. "Law, Finance, and Economic Growth in China." Journal of Financial Economics (2005): 57-116.Bailey, Warren B., Huang Wei and Zhishu Yang. "Bank Loans with Chinese Characteristics: Inside Debt, Firm Quality, and Market Response." 2008.Bradsher, Keith. "China's Informal Lending Poses Risks to Its Banks." New York Times 9 November 2004.Brandt, Loren and Thomas G. Rawski. China's Great Economic Transformation. London: Cambridge University Press , 2008.Consulate General of Switzerland in Shanghai. China's Banking Sector with a Focus on Shanghai. Survey. Shanghai: Consulate General of Switzerland in Shanghai, 2007.EarthTrends. Country Profile: Brazil. Washington D.C.: World Resources Institute, 2003.Fallows, James. "The $1.4 Trillion Question." The Atlantic Monthly January 2008: 2-3.Guangdong Provincial People's Congress. "Mortgage industry untapped, says BIS." Guangdong News 13 December 2007.He, Xinhua and Yongfu Cao. "Understanding High Savings Rate in China." China & World Economy (2007): 1-13.Hu, Biliang. Informal institutions and rural development in China. Chicago: Routledge, 2007.Jia, Chen. "Development of Chinese Small to Medium-sized enterprises." Journal of Small Business and Enterprise Development (2006).Liu, Chen Xiang. "SME Financing in China." Economics Working Papers, University of Paris (2007).NSBA. NBSA Small and Medium Sized Business Survey. Survey. Washington D.C.: NSBA, 2008.Pistrui, David, et al. "Entrepreneurship in China:Characteristics, Attributes, and Family Forces Shaping the Emerging Private Sector." Family Business Review (2004): 141-152.Tsai, Kellee S. "Congressional Testimony on China's Financial System." US-China Economic and Security Review Commission. Washington D.C.: USCC, 2006.Tsai, Kelly S. Back Alley Banking. Ithica: Cornell University Press, 2002.Woo, Wing Thye and Liang-Yn Liu. "Savings Behavior Under Imperfect Financial Markets and the Current Account Consequences." The Economic Journal (1994): 512-527.Woo, Wing Thye. "The Structural Obstacles to Macroeconomic Control in China." The International Journal of Applied Economics (2005): 1-26.Xinhua. "Pawnbroking may help finance China's small firms: adviser." People's Daily 27 January 2005.

Exhibit 1: Bad Loans as a Percentage of GDP (2006)

Source: Brandt and Rawski: p. 521

Exhibit 2: Formal Financial Systems

Exhibit 3: Informal Financial Systems

Exhibit 4: Urban Savings and Investment

Source: Woo (2004): p. 36, personal calculations (urban figures)

Source: Cao and He (2007): p.3

Exhibit 5Source of FinancingPercent of Total

Paid-in Capital26%

Retained Earnings30%

Informal Channels37%

Formal Channels7%

Source: Liu (2007): p. 3