China has approved plans to set up a pilot zone in the eastern city of Wenzhou to regulate private financing activities, the State Council, China's cabinet, said Wednesday.

China announces pilot financial reform zone in Wenzhou.

The long-awaited decision comes as underground private financing activities in Wenzhou, a major source of funding for the nation's small and medium-sized businesses, have stirred up financial disputes and crime and threatened financial and economic stability.

Effectively sorting out Wenzhou's problems and making financing serve the real economy are not only important for the healthy development of Wenzhou, but also of great pioneering significance for financial reform and economic development throughout the nation, according to a statement released after a State Council executive meeting presided over by Premier Wen Jiabao.

It was decided at the meeting that the reform program will include 12 major tasks.

The government is studying the implementation of a file management system for private financing and improvements to the fund monitoring system, the statement said.

The participation of private capital -- in the shape of setting up or taking shares of the rural banks and credit companies -- is encouraged and supported in the reform of local financial institutions.

Eligible micro-finance companies could be transformed into rural banks.

Private funds will also be guided toward the establishment of venture capital and private equity activities as well as other types of investment bodies.

The government will also examine a pilot scheme that will allow the city's residents to make direct offshore investments by creating regular and convenient direct investment channels, the statement said.

It will encourage qualified state-owned banks and share-holding banks to set up special units to deal with credit grants to small enterprises.

The government also vowed to encourage the establishment of financial leasing enterprises that serve small and micro enterprises as well as sectors concerning farmers, agriculture and the city's rural areas.

Other steps of the pilot program include measures to standardize and legalize transactions of non-listed companies' shares, technologies and cultural properties, encourage small and micro companies to issue bonds in Wenzhou, set up guarantee mechanisms for small and micro companies, and encourage commercial insurers to participate in the establishment of a social security system.

It's a good signal but too early to judge the real effects without specific rules to support the program, said Cheng Huifang, dean of the College of Economics and Management at Zhejiang University of Technology.

Ye Tan, a noted financial columnist, has warned about the financial risk controls. Capital outflows might be bigger than expected because although the test direct offshore investment project has been launched in Wenzhou, it might attract capital nationwide, according to her.

Wenzhou, with a population of over 9 million in east Zhejiang province, is famous for its private businesses.

The idea of Wenzhou financial reform zone first emerged in late 2011, after media reports of Wenzhou entrepreneurs fleeing or committing suicide as they were unable to repay high-interest underground loans amid a slump in export demand.

The city's private business owners turned to underground lenders after normal loans become difficult to obtain due to the government's tight monetary policy to combat high inflation.

As the government stepped up efforts to regulate the underground lending, several business-people have been detained or convicted, including Wu Ying, a businesswoman in Zhejiang who was once listed among the country's richest women and now faces death penalty for fraudulent fund-raising.

When commenting on the case of Wu Ying, Premier Wen Jiabao had said earlier, "we need to guide and permit private capital into the financial arena, standardizing it and bringing it into the open, encouraging its development and strengthening its supervision."