($190.34 million) in new loans to SMEs, a sharp drop from 9.8 billion yuan ($1.43 billion) during the same period last year.

In the aftermath of the credit crunch, commercial banks have been imposing much higher lending rates on SMEs than nominal ones and increasing their collateral requirements. This has further pushed up funding costs.

Observers say banks avoid lending to SMEs they deem uncreditworthy, fearing that they will get stuck with bad debts. Other factors also play into the SMEs' predicament, such as the appreciation of the yuan and falling overseas demand for Chinese imports. Rising interest rates for private loans, fuelled by vibrant demands, also have been pushing SMEs with weak solvencies to their limits.

With no other choice, most SMEs look to underground lenders for money that is outside the country's shelter of legal protection. Take Wenzhou, a hotbed of SMEs in Zhejiang, for instance. Its enterprises have been reshaping their funding tactics in recent years. The proportion of their own capital, bank loans and private financing has changed from 60:24:16 in 2006 to the current 54:18:28, according to the Wenzhou Banking Regulatory Bureau. This means that the SMEs in the area now rely more heavily on underground lenders to sustain their financing.

Money migration

For millions of underground lenders in the province, the small-loan program is absolutely cheery news. After acquiring a microlending license, they will be able to transform themselves into legal lenders.

In recent years, the Chinese Government has kept a firm hand on bank lending activities to combat inflation, which has created more opportunities for underground lenders to thrive. Some of them have been able to rake in windfall profits through rampant lending at shockingly high rates under the guise of guarantee companies, asset management companies or financial pawn shops.

According to data from the Wenzhou Financial Office, the city registered a dizzying 600 billion yuan ($87.85 billion) in current funds swirling around the country in 2007, while the provincial total was more than 1 trillion yuan ($146.41 billion). Zhao Qingming, a senior researcher at the China Construction Bank, told Shanghai Securities News that the scattered disposable money could be used for small loans, which are much more secure than those obtained through loan-shark operations. This also could make a dent in the massive underground lending industry, which poses a threat to the country's financial stability, he said. Private lending rates could also be kept low, because microlenders would intensify the competition, he added.

But Zhao also pointed out that microfunding only has a limited appeal to underground capital. Its regulated interest rates and a relatively high entry threshold may deter some speculative money. Moreover, small lenders are subject to requirements on diversified loan receivers, which go against private lenders' instinct to chase maximum returns, he said. The prohibition on savings activities may create a bottleneck for the companies to play a larger role in financing the SMEs, Zhao said.

But some other observers say the province's well-intended microlending initiative will likely broaden the financing channels for SMEs. If the trial