Photo: flickr: Wootang01
The Chinese government admitted that there is about $400 billion in their underground banking system.Societe Generale economist Wei Yao, however, estimates that it could be much higher— something more like $470-627 billion. They’re calling for the government to intervene.
So here’s how it all goes down. China is trying restrict, so banks aren’t lending to small and medium sized businesses, because they consider them too risky.
They are, however, still giving to big, state owned companies.
The big guys get good interest rates of around 7.2% from banks, then turn around lend to desperate smaller businesses at rates of 60% to 180%.
Basically the underground system isn’t underground at all, its on the balance sheets of China’s biggest businesses.
Despite their crazy rates, these so-called “black banks” have plenty of customers. Together, Chinese small to medium sized businesses make up 70% of employment on the mainland, and about 60% of the country’s GDP.
The assumption is that businesses who actually pay those astronomical loans back are engaged in some kind of speculation.
So now officials are cracking down on cities like Wenzhou that are known for having huge underground banking systems. There, an estimated 18% of the $94 billion in banks loans are in black banks. Those loans are held by a staggering 90% of households and 60% of businesses.
Last month, law enforcement began the hunt for business owners who had taken their loans and skipped town, leaving their employees and merchandise to rot. Since the beginning of the year, 19 of them have left the city. Last week, one of those one of those employers, a shoe factory owner, killed himself. This a pretty common outcome.
Human toll aside, underground banking also creates a system of financial dominos. If the economy slows down, (like say, during a global economy downturn) and private businesses can’t pay their loans, then everyone suffers.
Societe Generale predicts that the first casualty would be the housing sector. Black bank housing loans increased 23% year over year in the period from January to August of 2011— now they make up about 20% of all housing loans.
So ideally, prices should stay the way they are to keep the domino effect from kicking in. Unfortunately, The Chinese government wants prices to fall so that housing can become more affordable for ordinary citizens. If they do, that would reverberate through the underground banking system, and up to formal banks.
If they’re left alone, underground banks will do that anyway, taking down healthy banks and large businesses.
So China has a tough choice to make. Make borrowing easier for the average person, lower interest rates, risk inflation, and make loans more transparent.
Or they can maintain this system, keep the economy cool on the surface, and risk a bomb going off in the underground.