By Samuel Shen and Michael Flaherty
SHANGHAI/HONG KONG, July 9 (Reuters) – Wang Zhiyong, the
founder of a Shanghai-based gift card company, tried twice to
get a bank loan for his business and failed both times.
So Wang turned to China’s vast network of alternative
lenders, opting for a so called “curb side” loan. Such a loan is
just one segment of the country’s shadow banking system, which
includes pawn shops, credit guarantee firms, trust companies and
other mechanisms as sources of funds for Chinese borrowers.
“Banks never lend a hand to start-ups like us,” said Wang,
40. “They only go after big companies and state-owned firms.”
The dearth of bank credit available to China’s millions of
small to mid-sized companies is expected to tighten as
authorities seek to rebalance the world’s second-biggest
economy.
The central bank briefly allowed short-term interbank rates
to surge last month to crack down on lending tied to property
speculation and bloated local government debt.
The crackdown, however, only reinforced the dependency of
many of China’s non-state backed enterprises on the shadow
banking industry.
Fitch says some 36 percent of outstanding credit in China,
or 34 trillion yuan ($5.55 trillion), lies outside banks’ loan
portfolios, a huge pool of money which market participants find
difficult to track and which could cause an ugly credit mess in
a steeper slowdown.
Beijing now faces the difficult task of trying to re-direct
a non-bank financing system – created by the government’s own
lending policies – that has helped keep its economy humming.
“Shadow banking activities have increased because China
needs growth, and the banking sector has to a significant degree
failed in its role of financial intermediary,” Credit Suisse
said in a February research note.
For Wang, the greeting card company founder, tapping the
shadow banking industry was his only option, given that banks
usually do not lend to small enterprises and the stock and bond
markets in China are virtually shut.
He received a 5 million yuan, six-month loan from the curb
side lender, which charged him an annualized interest rate of 14
percent, or about twice as much as a bank loan.
ON THE CURB
The term shadow banking refers to any financing provided by
a non-bank entity.
The benefits of such a system are that it has allowed China
to liberalise its state-mandated interest rate policy – albeit
in an unorthodox manner. It’s also promoted a diversification of
funding mechanisms inside the country.
The risks come from building a system of credit largely out
of view of regulators and also one without a control mechanism
to assess if borrowers are even credit worthy. China, for
example, has never had a corporate bond default, and analysts
question whether risk is being priced appropriately.
China’s shadow banking boomed after a 2010 directive from
Chinese authorities to restrict the flow of bank loans. Beijing
was worried that the waves of loans prompted from a 2008
stimulus package was pushing up inflation, among other concerns.
Banks could lend to state-backed companies, but most of China’s
other corporations would have to find other methods of accessing
capital.
Non-bank lending has since flourished. China’s shadow
banking industry includes thousands of unofficial credit
providers, pawn shops, trust firms, and various other loan
vehicles.
On the flip side, it also includes so called “wealth
management products,” which are short term investment vehicles
sold by banks to the public, offering rates above the
state-mandated 3 percent savings rate. The products have allowed
banks to encourage parking money with banks even with inflation
rising.
With a tacit nod from Beijing, the banks can act as
intermediaries for shadow bankers and their clients without
taking debt onto their balance sheets.
With the crackdown, China’s regulators have taken aim at the
sale of wealth products as well.
The interbank lending spike in June that was engineered by
China’s central bank hit banks that were overly reliant on short
term borrowing, a reliance that analysts say came, in part, from
funding wealth product payouts promised at the end of each
month.
PAWN SHOPS
Curb side lending is a legal but unregulated type of high
interest loan, the main advantage being the speed in which the
money is handed over. Executives giving loans on behalf of their
companies, peer-to-peer lending networks and family members with
money to spare are considered part of this lending industry.
Monthly interest rates can exceed 40 percent, or annualised
rates of nearly 500 percent.
China’s pawn shops, which are licensed and regulated, are a
key layer of shadow banking, offering an array of non-bank loans
to individuals and companies. Bank of America said in a research
note last year that the size of China’s pawn shop industry at
the end of 2011 was 118 billion yuan.
The current size is around 500 billion yuan, according to
Joe Zhang, the Chairman of Wansui Micro Credit in Guangzhou.
Interest rates can go up to 35 percent on pawn loans, Zhang
says, with durations usually around three to six months.
One major advantage in borrowing from such an entity is
speed and efficiency. The loans can go out in days, sometimes
delivered in person, unlike the months it takes for a bank.
Wang Fuming, chairman of Shanghai Oriental Pawn Co, said his
company plays a key role in helping China’s small businesses,
since it lends to companies that banks see as high risk.
“We do what banks don’t do,” Wang said.
Oriental Pawn, which is one of Shanghai’s biggest pawn
shops, charges 4.7 percent per month on loans using cars as
collateral, and 3.2 percent per month on loans using real estate
as collateral, according to its web site, at six month tenures.
During Communist rule from 1956-1987, pawn shops were banned
in China. By the end of 2012, there were 6,084 pawn companies in
China, up 16 percent from a year earlier. Total assets of the
industry was up 34.3 percent to 116.8 billion yuan, according to
the Commerce Ministry.
Wen Shijie, owner of a small funeral service business,
walked into Oriental Pawn’s Shanghai headquarters with a gold
necklace.
Standing near a line of oil paintings, a statue of Marilyn
Monroe, and rows of luxury watches, he approached one of the
counters and made his case. Wen was able to borrow 10,000 yuan
against the necklace, for a short-term loan at a rate of 4
percent per month.
“I just want the money for emergency purposes,” he said,
adding that he preferred that type of loan rather than borrowing
from family.
DRINKING ‘POISON’
Beijing’s crackdown on risky lending in a slowing economy
puts the government in a tricky situation. By targeting the more
risky type of loans, its efforts may tighten a lending system
critical to providing credit to non-state backed entities.
“Shadow banking is actually playing a positive role in
China’s economy, because the current financial system is not
very reasonable or sound,” said Yan Hong, a finance professor at
Shanghai Jiatong University.
But Hong also acknowledged that the degree to which shadow
banking eases funding shortages for small to medium enterprises
was becoming disproportional.
“There’s the risk of quenching thirst by drinking poison,”
he said.
($1 = 6.1258 Chinese yuan)
(Additional reporting by Pete Sweeney in Shanghai and Lawrence
White in Hong Kong; Editing by Raju Gopalakrishnan)
