GOING UNDERGROUND

Despite China's efforts to tackle inflation with tools ranging from reserve rate hikes and outright bans on certain loans, inflation is still elevated. It ran at an annual pace of 5.3 percent in April and is expected to have accelerated in May.

The policies are affecting lending: growth in new yuan loans on banks' balance sheets dropped to 17.5 percent in April, from December's 20 percent.

Small firms are disproportionately hit by the slowdown.

For banks, it pays to avoid SMEs as they need to lend less this year to keep policy tight. To play it safe, they lend to big state firms instead of small private ones, which are deemed to be riskier.

"We have grown very selective of our clients," a banker at a mid-sized Wenzhou bank said. "We only lend to small companies that have very good growth prospects or are involved in new energy and new technology."

For the majority of small firms that do not make the cut, even offers to pay well over one-year benchmark lending rates of 6.31 percent get rebuffed.

Chinese banks report that SME loans make up about 40 percent of total lending.

Off-balance sheet loans,a category that includes wealth management products, are growing, the banker said, but few of these are going to small firms.  

Cash starved, many Wenzhou companies turn to the underground lending market.