Photo: AP Images
As China tightened credit lending to cool inflation and stabilise its property market, many Chinese small and medium business owners took to the underground banking system — borrowing from friends, relatives, and members of their community. When these entrepreneurs failed and defaulted on their loans, many fled. Some even committed suicide. recognising the dangers to the economy, Chinese premiere Wen Jiabao recently called for more financing for small and medium enterprises (SMEs). And now, it’s been reported that China’s banking regulator has increased the loan quota for Wenzhou, the worst hit city.
The Wenzhou branch of the China Banking Regulatory Commission has reportedly increased lending by 100 billion yuan, according to MarketNews International. This is on top of the 60 billion yuan in one-year bailout loans that Zhejiang’s provincial government is reportedly seeking from China’s central bank. Zhang Yourong, head of the China Banking Regulatory Commission’s local branch, however denied the report in an interview with Guangzhou Daily.
Some think the worst of the panic over informal loans is overblown, now that Wenzhou is addressing the issue. Hong Kong based economist Wang Tao (via Bloomberg) believes the hysteria about informal lending is tapering:
“The size of informal lending is relatively small and the concerns about the direct impact on the formal banking sector and the economy are exaggerated. …Bigger risks are credit withdrawal in both the formal and informal lending market and contagion.”
Here’s what we know:
The People’s Bank of China estimates that Wenzhou’s underground banking has reached 110 billion yuan, which is large relative to the 620 billion yuan in formal bank loans.
Underground banking for all of China is said to be between 3 trillion – 4 trillion yuan, according to Societe Generale analyst Wei Yao, as compared to 52.4 trillion by formal banks. It also accounts for 30% of the 14 trillion – 15 trillion shadow banking sector. (See the chart below.)
Yao said the SMEs’ willingness to borrow at mind-boggling rates, which range between 20% – 180%, reflects one of two things. Either they are desperate for funds or they’re involved in unproductive, speculative activity. If it’s the latter, the central bank wants to see it weeded out. The problem arises when high borrowing rates impact legitimate businesses, that are at a disadvantage because formal credit tends to be available only to big companies and state-owned enterprises.
Yao expects the situation to get worse in coming months as demand for cash is expected to increase towards the year’s end. In fact, She also warns that a downturn in the property sector could make this currently local problem into a systemic one:
“We can only imagine smaller developers have been pushed to more opaque credit markets for more costly funding. If property prices were to decline sharply, a domino effect could be triggered in the shadow banking system.”
Moreover the formal banking system could in turn be hit because of its exposure to the property sector.
Now here’s a chart from SocGen that shows the China’s underground banking relative to its entire shadow banking system:
Photo: Societe Generale