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Underground lending waiting for the sun

By Bi Xiaoning (China Daily)
Updated: 2008-09-08 14:55

"If you haven't suffered the risks and opportunities, you can't understand the light heart when the sunshine comes," says Huang Debin, a private lender in Zhejiang province.

The "sunshine" Huang refers to is the legitimization of the underground private lending sector and establishment of a limited number of microcredit companies in order to connect private capital with small and medium-sized enterprises (SMEs). The risks are what Huang and other loan sharks take when they loan money at higher interest rates.

In May, the China Banking Regulatory Commission (CBRC) and the country's central bank, the People's Bank of China, jointly released guidelines for establishing micro-credit companies and Zhejiang province was selected as the first pilot area.

In July, the Zhejiang provincial government announced that 111 micro-credit slots were allocated to its counties. The first group of newly lawful private lenders could start issuing loans as soon as October.

In general, each county will have one micro-credit company. Because of their large liquidity, Wenzhou, Hangzhou, Jiaxing and Taizhou counties are allowed to have five additional slots for private lenders.

With 11 counties or townships, Wenzhou can have 16 legal private lenders during the unspecified trial period, but underground lenders still feel the quotas are insufficient.

Active ghost

Rumor has it that there is a 600 billion yuan ($87.46 billion) liquidity fund from Wenzhou that is active across the country. The history of the tremendous private capital can be traced back 30 years.

In the late 1970s, with China's opening up policy, Wenzhou became the country's well-known base for private workshops. In the late 1990s, with accumulated capital, the local businessmen began to seek investment opportunities throughout China.

In 2001, a large group of Wenzhou investors appeared in Shanghai and began buying up apartments. By 2004, news of Wenzhou's seemingly bottomless private capital began to emerge. Like ghosts, these smart investors reportedly appeared and disappeared mysteriously and seemed to be sensitive to any profitable projects, including real estate, the stock market, coal mines, foreign currencies and oil fields.

Due to the turbulence in the current stock market and real estate industry, the Wenzhou capital has recently begun to concentrate on the manufacturing sector.

According to a report by the Wenzhou branch of the People's Bank of China, in June, about 88.5 percent of local liquidity capital was used in the production field

Figures from CBRC Wenzhou branch show that the private liquidity capital active in Wenzhou is about 300 billion yuan and at least 40 billion yuan is available for private lending.

Angels and demons

The underground lenders have eased the financing difficulties for fund-thirsty SMEs, especially at a time when tightened monetary policies are drying up bank loans.

Since last year, China's benchmark interest rate has risen six times. The banks reserve requirement ratio - the deposit percentage required by the central bank - has also been raised 10 times in the same period. By June, the frozen capital in Wenzhou reached about 3.6 billion yuan.

A series of factors, including the fast appreciation of the yuan, rising material costs, a lower export tax rebate rate and the slowdown of the world's major economies, have added up to a very inhospitable atmosphere for SMEs.

As a result, many SMEs have turned to underground private funding channels. By analyzing the capital resources of SMEs in Wenzhou, one can find the proportion among self-owned capital, bank loans and private lending was 57:37:6 at the end of 2003, but changed to 54:18:28 at the beginning of this year.

For the SMEs, the private lenders are both angels quenching their capital thirst; yet, the high interest rates are the demons that can put them through hell.

Last December, the monthly interest rate of private lending in Wenzhou reached as high as 1.16 percent a month (compared to an average of 0.6 percent monthly from a bank) and it increased to 1.225 percent a month this June. And the rising interest rates are a common scene in other counties of Zhejiang province.

Feiyue Group, the sewing machine manufacturing leader in China and the model of township enterprise in Taizhou of Zhejiang province, had turned to underground lenders to maintain its cash flow, but the high interest rates left Feiyue struggling to pay the debts. In May, the company's founder Qiu Jibao had to apply for bankruptcy.

Once the capital chains break, the guarantors can't escape from the payment crisis either. In July, Zhu Jiguang, a manufacturing boss in Zhejiang, committed suicide for failing to guarantee the loan of his friend and as a way to evade the creditors.

"Private lending fills the vacuum created by banks which are less enthusiastic about lending to SMEs, but it deviates from the normal track and seeks high profits blindly and even illegally," says Qian Liang, an experienced lawyer in Zhejiang.

Shine a light

The setup of the first batch of legal private lenders is around the corner now and it's a welcome beacon for the underground private lenders as well as the SMEs.

Guo Jian, a private lender quoted previously by China Business News, said, "I have been anticipating a legitimate private lending market. Maybe the interest rate will be lower than before, but the loaned capital can also be much safer. At least, we can ask for the payment of bad debts via lawsuits."

Yet, most underground lenders, while they can glimpse the light, they can't bask in the sunshine, because the entrance requirements to go legitimate are still too high.

According to the new policies micro-credit firms will be chosen from leading private enterprises whose net assets are no lower than 50 million yuan, who have been profitable for three years in a row, with revenue higher than 15 million yuan.

In Wenzhou, the threshold is even higher. The registered capital in five of its counties is required to be 200 million yuan while in other places 100 million yuan is enough.

"Even if the registered capital of the 16 micro-credit companies in Wenzhou is 200 million yuan each, the total amount is just 3.2 billon yuan. It is still too small when compared with the 600 billion liquidity private capital," says Zhou Dewen, president of the Wenzhou council for the promotion of small and medium-sized enterprises.

But small private lenders worried about being excluded from the first batch of micro-credit companies are now pinning their hopes on another favorable policy - a proposal to regulate creditors.

However, the central bank says further study of the new proposed by law is needed.

"Besides defining the legal status of the private lenders, the new policy should pay much attention to the qualification of lenders, their clients and the fluctuation scope of interest rates," says Zhou.

Fang Peilin, president of a small guarantee company in Wenzhou, says: "The new policy could make the lending market more transparent. The high interest rate of private lending will decline."