The People's Bank; As it dies out in London, private banking emerges in informal Chinese style, ready for entrepreneurs.

Byline: Craig Simons

Most bankers would be worried if Li Qiyou walked into their office. Dressed in a cheap blue suit, the 45-year-old resident of Wenzhou, a city in China's coastal Zhejiang province, grew up in the countryside during the Cultural Revolution and has only a second-grade education. In the early 1980s, he borrowed the equivalent of $1,000 from friends and relatives and started a brewery, but "it lost money for three straight years," he says. In China, the odds of someone with Li's background getting a bank loan are even smaller: the country's giant state-owned banks almost never lend to individuals, regardless of how good their ideas are. "To get a loan," Li says, "you either have to be rich or well connected."

But in Wenzhou, entrepreneurs have a second chance. The city, 230 miles south of Shanghai, is the center of China's booming gray market in informal loans: billions of dollars that flow outside of the formal banking system and fund most of China's small- and medium-size enterprises, from tiny restaurants to factories making everything from doorknobs to engines. Increasingly, those firms are driving China's economy. While 10 years ago the state sector was dominant, the private sector now creates some 60 percent of China's GDP and 70 percent of new job growth. According to Kellee Tsai, a professor at Johns Hopkins University who specializes in China's informal banking, roughly one third of all Chinese loans are now given privately, including by one or two private banks. At a time when small, elite private banks are dying out in Europe, they are emerging in an entirely different, aggressively democratic and entrepreneurial form in China.

In Wenzhou, private businesses--almost all of which were financed with private loans--have helped the city maintain 15 percent annual growth for more than a decade. And economists say a recent drop in new Chinese savings deposits is evidence that the informal sector is growing.

Li is a good example of how the informal market works. After failing as a brewer, he borrowed more money from local lenders in 1984 and started an electrical-parts company. Since then he has rolled profits over to start a sink factory that employs 40 people and did $600,000 of business last year, exporting to New Zealand, Iran, Dubai and Turkey. Li has paid off his loans and now helps friends who need a financial boost.

Gray market lenders, who range from acquaintances to co-ops of wealthy business people, are ...