In July, Wenzhou’s underground banks processed 110 billion yuan ($15 billion), about 40 percent more than the 80 billion yuan processed in the same month a year earlier and equal to more than one-third of the city’s entire GDP of 292.56 billion yuan for last year, according to statistics from the Wenzhou branch of the PBOC.

But the high risks inherent in underground banking inevitably brought damage to the city.

At the beginning of April, many SME owners disappeared after failing to pay back money borrowed from underground banks. Huang He, the chairman of Wenzhou Jiangnan Leather Co Ltd, closed down his factory without warning, owing billions of yuan to workers and moneylenders.

“I came to work as usual in the morning and found out that the gate was shut and a group of people had gathered outside the factory asking the boss to return their money,” said a former worker who would only give his name as Yao.

He added that he still hadn’t received his salaries for March and April and he didn’t expect to get his money after learning that Huang had already moved overseas.

Wenzhou Shoes Material Co Ltd unexpectedly ceased production on Aug 29, and just a few days ago, the boss of Wenzhou Jinchao Electrical Appliances Co located in southeast Wenzhou’s Yueqing city, was also reported missing. There has subsequently been speculation that he is in trouble with an underwriting company.

Wenzhou Tietong Electrical Equipment and Alloy Industry Ltd Co, Wenzhou Shoes Material Ltd Co and Wenzhou Jinchao Electrical Equipment Ltd Co all fell into the same trap in August.

“All those businessmen were involved in borrowing money from underground banks and they failed to return the money with the high, ever-increasing interests on time,” said Xu Liangxi, deputy director of the Wenzhou Marketing Management Association. “The vicious circle has already begun to devour the companies’ capital, causing problems for firms that have been in operation for 10 to 20 years.”

As a result of these defaults, private moneylenders worry about the increasing risk of lending money to SMEs.

“Most of us have been scared by the recent mass defections of businessmen so we have to double check all company information in detail before lending money, and a written IOU is essential now,” said Wang Jianxiao, the owner of a private underground bank in Wenzhou who used to lend millions of yuan to SMEs during the peak period without any formal IOUs.

Wang added that the tightened loan policies have restricted the cash flow for businessmen, forcing them to return the money to the lenders.

Most of the moneylenders and collectors have temporarily ceased loaning out large sums as they are wary of losing out.

“The collapse of the underground banks, which would be the worst consequence for the private money lenders and borrowers in Wenzhou, will become a reality sooner or later if the cash flow problem is not solved,” said Chen Gongmeng, chairman of Wenzhou Strategic Investors Federation.

Chen added that hopefully the official bank loans policy will ease and that more underwriting companies will lend money to SMEs at lower interest rates than those offered by the gray market lenders.