Shadow Loans Hard to Squelch in China City Hit by Suicide

Shadow Loans Hard to Squelch in China City Hit by Suicide

Zhou Xiang is playing with his mobile phone in a room just big enough for a desk and chairs at the year-old Wenzhou Private Lending Registration Center. Not a single prospective customer has shown up for hours.

As a government-sanctioned loan broker seeking to match cash-strapped business owners with private investors, Zhou is one of the few people who can even be found inside the two-story building in a high-end residential district of Wenzhou, a city of 9 million people in China’s southeastern Zhejiang province. Rows of airport-like seats are empty.

“Only those who are really out of options would come here for loans,” says Zhou, a manager at Sudaibang, one of five independent brokers operating out of the center. “Most of the time, you would find these firms so weak financially that they can be literally crushed by a straw. The volume of lending is so low that we ourselves won’t be here long without expanding into some other businesses.”

One year after China’s leaders picked Wenzhou to start a pilot program designed to curb and regulate the city’s informal shadow-lending networks, it’s clear, based on a recent trip to the country’s epicenter of private lending, that the plan isn’t working. Small firms it intended to benefit still can’t access loans because they lack collateral and are struggling to stay afloat. At least one broker, Beijing-based CreditEase, has given up, citing a gap between the center and targeted borrowers.

Feeling Pain

“We made some efforts and progress, but we didn’t achieve any meaningful breakthroughs,” said Zhou Dewen, chairman of the Wenzhou Small and Medium-Sized Enterprises Development Association, which has more than 1,000 members. “To reform means to take bold moves and not be afraid of making mistakes, but no government officials are willing to put their jobs on the line. If they could feel the pain of small businesses, they may understand that Wenzhou is running out of time.”

Former Premier Wen Jiabao announced the project last year after more than 80 businessmen, unable to make payments on underground loans, committed suicide or declared bankruptcy in Wenzhou over a six-month period. The plan was approved by the State Council on March 28, 2012. At the National People’s Congress in Beijing this month, where Li Keqiang took over the premiership, no top government leader mentioned the program or any measures to curtail shadow banking.

Of 12 measures proposed by Wen, only two — the opening of the registration center and allowing qualified small firms to issue bonds — have gotten off the ground. While officials in other Chinese cities have indicated a desire to copy Wenzhou’s lending center, none has.

Shadow Lending

Shadow lending flourishes in China because an estimated 97 percent of the nation’s 42 million small businesses can’t get bank loans, and savers are seeking higher returns than lenders pay for deposits. UBS AG estimates the size of the industry, including private lending, banks’ off-balance-sheet vehicles and trusts, at $3.35 trillion, or 45 percent of gross domestic product. A study by Zhou of the Wenzhou association and a group of academic researchers put the amount of private lending among individuals at about 3.7 trillion yuan ($596 billion).

Private lending in Wenzhou stood at about 120 billion yuan at the end of 2012, a 20 percent decline from the peak two years ago and accounting for 17 percent of official lending, Zhou said. Failure to put what he estimates is 800 billion yuan of idled private capital to better use is affecting the economy.

Ferraris, Porsches

Wenzhou isn’t as frenzied as it was a year ago. Wangjiang Boulevard, once known for its neon lights and night clubs where businessmen gathered, is quieter. The Ferraris, Porsches and other luxury cars that blanketed parking lots are gone. Some pubs have been turned into tea houses, while others have closed.

As more than 400,000 small businesses ranging from eyewear makers to cigarette-lighter exporters struggled, Wenzhou’s economy expanded 5.7 percent in the first nine months of 2012 compared with 7.7 percent nationwide, government data show. Bigger firms didn’t fare much better: More than 60 percent of the city’s 3,998 major industrial companies had cut production, according to a July survey.

At the Wenzhou lending center, the 594 million yuan in loans made as of March 11 represent just 0.5 percent of the value of the city’s underground-lending market, according to Chen Xijun, a director of the local Chamber of Commerce.

“This is significantly below our expectation and has become an embarrassment,” Chen said in an interview. “We had thought that all of the city’s private capital would have emerged after the registration center.”

‘Dirty Laundry’

Lack of collateral is the main constraint for potential borrowers, and some also have balked at the idea of “airing their dirty laundry to the public” by showing up at the registration center, Chen said.

If small businesses have enough collateral, they can get bank loans at a cheaper rate than from the Wenzhou center. Brokers there charge 18 percent annual interest plus fees, which can typically be 1.8 percent of the amount borrowed for a three- month loan. Sudaibang, which offers short-term financing of less than 1 million yuan, charges 0.6 percentage point on top of the 1.2 percent to 1.4 percent monthly lending rate, equivalent to 24 percent on an annual basis, the highest allowed by law.

The average annual interest rate for bank loans by comparison stood at 6.78 percent in December, according to China’s central bank.

Meanwhile, only two small Wenzhou firms have sold bonds through private placements. The total: 200 million yuan.

Rural Banks

Another part of Wen’s pilot program, allowing investors to set up privately owned rural banks specializing in serving small businesses, was rejected three times over the past year by the China Banking Regulatory Commission, and the local government is unwilling to submit more applications, according to Zhou. China allows private investors to take minority stakes in rural lenders only if a commercial bank is the main initiator and owns at least 15 percent to ensure risk control.

Two major issues in Wenzhou — too many small firms without access to capital and too much private capital without a place to invest — haven’t eased at all, Wenzhou Mayor Chen Jinbiao told fellow legislators at the National People’s Congress. In a speech at a session open to the media, he urged the public to lower expectations and appealed to top regulators to give the city more freedom to implement policies.

“Wenzhou’s reform needs policy and legal support from the very top,” Chen told delegates on March 7. “Hopes are high, and implementation is tough. We should be more realistic. Financial reform is vital to the economy, but it’s not a panacea that can fix all the problems.”

Chasing Yield

China’s slowest growth in 13 years and a weakening property market are squeezing millions of Chinese who invested the money of friends and acquaintances chasing higher yields, making it difficult for them to honor those payments. The slowdown also is putting pressure on the government to rein in private lending to avoid defaults that could increase the number of victims and lead to social unrest.

Record profits at state-owned banks and restrictions on private investment in financial firms drew criticism from entrepreneurs at the month’s top legislative meeting in Beijing.

“On one hand, we have banks that are ashamed of the massive earnings they easily made, and on the other hand we have millions of small businesses that are on the brink of bankruptcy,” Hu Jiqiang, chairman of Zhejiang Conba Pharmaceutical Co. (600572), a small-business owner and a National People’s Congress delegate told the conference. “Reform must be taken, and the monopoly must be broken. Helping today’s micro firms is cultivating tomorrow’s global 500.”

Moonlighting Cabdriver

Only 3 percent of China’s 42 million small- and medium- sized firms currently borrow from banks, according to Citic Securities Co. (600030), a Beijing-based brokerage. Lack of credit history and collateral force many to seek financing from underground lenders, according to Zhou of the Wenzhou small- business association.

At least 25,900 lawsuits involving disputes over 46.2 billion yuan in private lending were filed in Wenzhou in 2012, a more than sixfold increase from a year earlier, according to the supreme court of Zhejiang province.

Chen Shenghua, who runs his own taxi company in Wenzhou, is now moonlighting as a driver after losing 1.5 million yuan of savings. Chen took out a bank loan using one of his properties as collateral and lent the money to a friend at a monthly interest rate of 5 percent. He was never paid back, he said.

He sued, only to find there were dozens of victims like him who were owed tens of millions of yuan, and no assets were left to pay the debt.

“I only lend to people who can provide me with collateral and a notarized lending contract,” said Chen, who still has about 1 million yuan lent to acquaintances who pay him a monthly rate of 3 percent. “I don’t believe in friendship anymore.”

Nonperforming Loans

Underground lending funded Wenzhou’s growth over the past decade, with almost 90 percent of families and 60 percent of companies taking part in 110 billion yuan of such financing, according to a 2011 survey by the People’s Bank of China.

Last year’s slowdown in underground financing left small businesses and the local economy struggling. It also led to a pileup of nonperforming debt at banks as borrowers were cut off from cash flows they needed to pay back loans.

The proportion of bad loans to total lending at Wenzhou’s banks rose to 3.43 percent in November from a low of 0.37 percent in June 2011, the Oriental Morning Post reported in January, citing the local banking regulator.

The actual level is higher than the official data, with some banks’ bad-loan ratios exceeding 8 percent, and the situation worsening, according to the small-business association’s Zhou, who has access to local banks’ figures through his members.

Withdrawal Threat

Ping An Bank Co. (000001), which had a bad-loan ratio of 0.95 percent at the end of December, said the ratio would be only 0.67 percent after excluding its Wenzhou branch, according to its 2012 annual report. About 75 percent of last year’s increase in soured loans at Shanghai Pudong Development Bank Co. (600000) originated from Wenzhou, the 21st Century Business Herald reported on March 14, citing Vice President Liu Xinyi.

The rise in nonperforming loans further weakened the ability of banks to lend to private businesses. Wenzhou’s Leqing district government even threatened to withdraw deposits from any lender that called in loans from struggling small businesses, the China News Services reported.

Shoes Returned

Li Jianlong, marketing and sales director for Wenzhou Fulite Shoes Co., said a cash-strapped customer recently returned 4,000 pairs of shoes to the company’s factory on a dusty street. The buyer couldn’t make payments and was unable to qualify for loans. The shoes were resold to North Korea for 14.5 yuan each, resulting in a loss of 200,000 yuan, Li said.

“At least we got the shoes back,” Li said. “You know, he could just disappear like many others, and we can’t do anything about it. There’s one rule that we made very clear with our customers: No matter how much money you owe us, you must make some payments before the day we pay our workers.”

Labor costs have kept rising as many migrant workers left Wenzhou for their home towns, where living expenses and property prices are lower, or to places with better job prospects. Job postings for restaurant waiters to department store sales managers are everywhere in the city’s downtown.

Fulite Shoes can’t find enough entry-level workers, even after raising base salaries to 2,500 yuan a month including dormitory housing, up from 900 yuan in 2008, according to Li.

“I was excited when the government announced the reform here,” Li said. “But now I know that has nothing to do with micro firms like us. They draw us a pie that we can never eat.”

Liu Mingkang, a former chairman of China’s banking regulator, agreed.

“I don’t know what they are doing there,” Liu said about Wenzhou in an interview at the Beijing congress. “They’d better figure that out what they want to do first.”

To contact Bloomberg News staff for this story: Jun Luo in Shanghai at

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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