A credit crisis in Shenmu, a bustling northwest China county that built its riches on coal, has stoked concerns regarding how quickly the country can complete its economic transition.
Hundreds of underground banks that mushroomed in Shenmu during more prosperous times have failed to collect large amount of debts, as prices of coal and real estate have fallen sharply.
Lured by annual earnings of 20 percent, more than 20 billion yuan (3.3 billion U.S. dollars) in private funds is believed to have swarmed into local underground banks, which previously lent to investors at annual rates of more than 30 percent, according to a local resident surnamed Meng.
The borrowers could invest the funds in coal mines or real estate for higher profits, Meng said.
Underground lending also boomed due to the fact that small and medium-sized companies were unable to get loans from traditional financial institutions, as well as the limited investment options provided for private capital, said Huang Zhen, a professor with the Central University of Finance and Economics.
The capital chain was sustainable when coal prices were at high levels, but the situation changed when a slowing economy drove coal prices down.
The price of thermal coal, which is used to fire power plants, has declined 10.7 percent from the beginning of the year, according to the benchmark Bohai Rim steam-coal price index issued for the week ending on Tuesday.
The investment frenzy triggered significant coal production expansion. However, waning demand has caused 88 of the country's 99 mines to suspend production, said Gao Haixiong, deputy director of the county development and reform bureau.
"Coal mine owners used to have no hesitation in spending 100,000 yuan on a luxurious dinner. But now after the fund chain ruptured, many have sold their luxury cars to repay debts," said a mine owner who declined to be named.
Shenmu relies heavily on industry and the output of the coal industry accounts for over 70 percent of the county's total industrial output, according to Gao.
The credit squeeze has also been linked to falling housing prices, which have decreased by 50 percent, bringing huge losses to a large number of real estate investors and paralyzing construction.
Many underground bankers have fled the area following the credit crisis and some have even committed suicide after failing to pay depositors back.
Similar crises have occurred in Wenzhou, a manufacturing hub in east China's Zhejiang Province, and Ordos, a coal-rich city in north China's Inner Mongolia Autonomous Region, over the past two years.
Many low-cost manufacturing enterprises in Wenzhou went bankrupt in 2011 due to rising labor costs, the appreciation of the yuan and tightened credit. Many of the companies' owners fled or even committed suicide. Some local underground bankers also committed suicide after failing to repay debts.
A private lending boom that came on the back of record coal prices spurred a huge property bubble in Ordos. However, a credit crisis has slashed housing prices by more than half, leaving many newly-built residential communities unoccupied and turning parts of Ordos into ghost towns.
The credit crisis has shown that the economy requires a transformation in order to ensure its health, Huang said.
Although there are some external factors behind China's slowing economy, long-standing internal structural problems are deeply affecting its growth potential, Huang said.
Last month, the State Council unveiled regulations allowing private capital to set up private banks, as well as financial leasing and financial consumption firms, to support an economic transition.
"We hope that declines in coal prices will encourage mining companies to transition and improve their industrial chain," said Zhao Cunfa, president of Shenmu's local coal mining association. "This is a lesson we should be taught sooner than later."
