17 November 2008
Chinese regulators have no idea how to control private lending.
HUANG WEIJIAN says he is not an underground banker or even a private banker. Normal bankers make money from interest payments and lose money at times of financial crisis. But Huang makes his biggest profits when borrowers go bust. "We are Wenzhou's first true venture capital company," he says, sprawling on his office couch, with his neon blue skivvy and designer jeans shining through the fog from his cigarette. "What we do is put money into banks and let the banks lend to companies," says Huang, who intends to invest a billion yuan ($226 million) this year. "If they repay the loan in time, that's fine, but if they don't, we acquire them. We target companies that are about to go bankrupt but still have a good economic foundation - we like firms to run out of money so they become ours."In all its infinitely variety, and despite 20 years of sporadic Communist Party campaigns to stamp it out, the informal banking system remains the lifeblood of entrepreneurial China. While the state-controlled banks tend to confine their lending to state-controlled firms and friends of the local Communist Party secretary, informal creditors take great risks to supply credit to small businesses that deserve it. Chinese regulators and analysts are mostly confident that the state-controlled banks are strong enough to withstand the global financial crisis. But they are sweating over informal banks, which they can't see. They know informal money has pumped up the share and housing markets and also the "unexplained capital flows" column of China's balance of payments data, but they have no idea how to quantify or control control it. "Private banking is often enforced by standover men," says Zhu Qiren, director of Peking University's prestigious China Centre for Economic Research. "A lot of that money didn't go towards production. It went into the sharemarket, pushing the index from 1000 to 6000. That is the problem."More precisely, many regulators and analysts believe the collapse of the share and property markets might imply that private lenders are in trouble, posing a major threat to the Chinese financial system.But in Wenzhou, the centre of what is probably the world's largest informal finance network, it seems the private lenders are more than capable of looking after themselves. Wenzhou's webs of private lending are held together by a gentleman's code. Borrowers are introduced and implicitly guaranteed by friends and relatives. Huang Weijin (who puts his special "venture capital" lending arrangements into a separate conceptual category) explains why local business people would rather lose their lives than default on a private loan. "I can fly to Europe or Africa with only 300 yuan because other Wenzhou businessmen will look after me. They drive to Germany from Italy to pick me up, and I would do the same. "It doesn't matter if you lose money. But if you lose trust, you lose everything."Those bonds of business kinship, extending across China and the global Wenzhou diaspora, are far stronger than the contracts that bind borrowers to faceless state-owned banks. "It's more secure than a state-controlled bank because if someone doesn't repay they have no place to play in Wenzhou any more," says Zhou Dewen, who heads the Wenzhou Small and Medium Enterprise Development Association. Zhou says private interest rates are sometimes 10 times the official lending rate, but the quantity of informal credit nevertheless ballooned earlier this year when the central bank closed official lending channels. More recently, he says, local bank deposits have swelled to 200 billion yuan as Wenzhou business people have cashed in their real estate and sharemarket investments. "Wenzhou people are full of strategies and know when to take risk and when to take a low profile," he says. It is the state-controlled banks that regulators should be worried about. In recent years the state banks have been cleaning up their non-performing loans and risk management systems. They have accumulated fat capital reserves, thanks to their privileged official status and regular government bail-outs. Now they're going to need it. A week ago the central government abandoned its five-year effort to clean up bank balance sheets by ordering them to open their vaults to save the economy. Officials at all tiers of government promptly scrambled to order local branch officers to fund ill-conceived infrastructure projects and bail out officially sanctioned businesses that had gone bad. The recent experience of Shaoxing county, a few hours drive from Wenzhou in Zhejiang province, foreshadows what will soon be occurring across the country. On October 20, Chen Yueliang, deputy major of Shaoxing, told a news conference attended by a local bankers that efforts to overhaul four favoured textiles companies "should be accelerated, regardless of cost. The Government will be responsible for any problems that emerge in the restructuring progress."Private bankers accounted for about one-third of their debts, according to Caijing magazine. Those loans are non-negotiable. But the state banks were ordered to keep the businesses alive. While the informal banks protect themselves, the state banks are being forced to act as a tool of macro-economic policy and local government cronyism.The state banks will power the economy through the current economic crisis, fuelling ever-greater economic imbalances and postponing the financial system account for another day.