Inside the world of China’s “shadow banks”; Huang Fajing, otherwise known as ‘The Lighter King,’ believes that shadow banking -which had innocent beginnings in Wenzhou – has spiraled out of control throughout China

Inside the world of China’s “shadow banks”

The coastal city of Wenzhou, population 9 million, is considered the birthplace of China’s thriving shadow banking sector.

by Rob Schmitz

Marketplace for Thursday, October 3, 2013

P1090065

Huang Fajing, otherwise known as ‘The Lighter King,’ believes that shadow banking -which had innocent beginnings in Wenzhou – has spiraled out of control throughout China.

Wherever you go in the coastal city of Wenzhou, you hear the sounds of people working, spilling out of thousands of small factories which line the streets. One neighborhood makes most of the world’s metal cigarette lighters. A couple of miles away, there’s a neighborhood devoted to shoe soles. The district beyond that? Felt tip pens. Nearly all of them are small, privately-owned businesses getting zero help from the government. According to Wenzhou businessman Huang Fajing, this — combined with the city’s geography — has created some of the keenest businessmen on the planet.“We’re a coastal city near Taiwan. The government was always scared Taiwan would bomb or invade us. So the government never bothered to invest any money in our infrastructure,” says Huang, pausing to take a drag on his cigarette. “They left us alone.”

Some here say the government got out of the way — allowing the capitalist-minded people of Wenzhou to develop their own economy, complete with a lending system that predates banks. A place where a loan is simply a pile of money pooled together by friends and family.

“I began making cigarette lighters 20 years ago,” continues Huang. “Four of my family members each put in $1,500 and lent it to me without interest. That’s what we call a Wenzhou loan.”

Thanks to his Wenzhou loan, Huang Fajing made a fortune selling cigarette lighters–Chinese media now call him the ‘lighter king.’

On his road to cigarette lighter fame and fortune, the Lighter King watched on as more money flowed into Wenzhou. Over time, loans were no longer limited to just family and friends. The ‘Wenzhou loan,’ says Huang, became a lot less innocent.

“Bigger groups of lenders began to form. They pooled money together and took turns taking out loans. Then they started lending money with very high interest rates – to strangers.”

This system of lending — in all its variations — is called shadow banking. It’s now popular throughout China. In a report earlier this year, JPMorgan Chase estimated China’s shadow banking industry could be worth up to 70 percent of the country’s GDP. China’s central bank has become so worried about this that in June it essentially froze lending between the country’s banks, sending global markets into a freefall. The big concern here is that if China’s economic growth continues to slow down, all these off-the-books loans won’t be paid back.

Along a busy thoroughfare in Wenzhou simply called ‘shoe street,’ shoe factories that export to Europe are now– like the EU — suffering.

Shoe factory owner Gao Shenyi sits inside his storefront sipping tea and smoking cigarettes with his friends. He wears a silver chain around his neck, bright red shoes, and a tight t-shirt filled with random English words: “staple text,” “free floral decorative pack,” “January,” and so on. The shirt’s tucked into bright white chinos, showing off a sparkly rhinestone belt buckle.

His friends are dressed like Chinese gangsters, too. There’s a reason for that.

“My friend lent some money to a businessman who agreed to pay it back with interest in 60 days,” mutters Gao, “But then the guy disappears. We’ve been looking for him, but he ran away.”

This has become common in Wenzhou. Private loan defaults have soared over the past two years. Dozens of Wenzhou businessmen unable to pay back their loans have gone missing or been found dead. Yin Zhichao, deputy director of the China household finance survey, has studied China’s shadow banking sector for years. He fears these types of defaults could lead to social instability throughout China.

“They have a sudden, far-reaching impact on everyone who’s lent that money,” says Yin. “From my point of view, China’s biggest economic risk isn’t from the existing banking system, but from this type of shadow banking.”

And now China wants to bring this sector out of the shadows. A year ago, it chose Wenzhou to start a pilot program to legalize shadow lending networks. It built a center where people can apply for these loans, with more tightly regulated oversight.

But here at the Wenzhou Private Lending Registration Center on a recent weekday, there isn’t one customer. Rows of chairs sit empty and dozens of staff pretend to look busy, surfing the Internet.

“It’s always this empty,” says Zhou Xiang, a loan officer who works here.

Zhou sits under a poster depicting a smiling elderly couple lying on their stomachs in a verdant meadow of wildflowers, admiring a butterfly collecting pollen. The sky is blue, and in the background, skyscrapers rise from the pasture. It’s a landscape that doesn’t exist in China, promising loans nobody seems to want.

“Most businesses that come here don’t have a credit history,” admits Zhou. “They just don’t qualify for a loan.”

Which is exactly how shadow banking started here in the first place.

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 (www.heroinnovator.com), 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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