A credit crisis bomb in Wenzhou – China’s informal lending system

by Denise Law, FT Tilt • Silas Berry – asiaconsult.org

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The Wenzhou government has unveiled a series of measures to help cash-strapped small and medium enterprises survive amid a tightening credit environment. But there are fears the SMEs have already become too reliant on the grey market, which is now a ‘time bomb’ waiting to explode, analysts said.

Banks must now issue at least Rmb100bn ($15.7bn) of new loans to small companies this year, and maximum lending rates should be no more than 1.3 times the benchmark rate, which is about 6.5 per cent, according to local media.

But it’s unclear whether these measures will help SMEs reduce their reliance on the illegal credit market, where informal money lenders charge up to 70 per cent annually. Given that the tightening is set to continue, as China’s fight against inflation remains a priority, it is unclear how feasible these measures are.

SMEs, unable to secure lending from the big banks — which prefer larger clients such as SOEs — have in recent months turned desperately to the grey market, or the shadow banking system. And Wenzhou, known for itswealthy and business savvy merchants, has become the poster child for what can go wrong during a period of tighter monetary policy, analysts said.

The grey market is a “short-term ‘time-bomb’ facing the Chinese economy”, and could be more damaging than the local government debt situation, said Dong Tao, a senior regional economist at Credit Suisse in Hong Kong.

The rise of the informal lending market is the result of monetary policy failure. China has tried to impose a one-size-fits-all strategy by raising the required reserve ratio and putting a cap on how much the banks can lend out,” he told FT Tilt.

This, as a result, has distorted the official lending rate.

“Actual lending rates have become much higher than the official lending rate, with informal money lenders charging as high as 6 per cent per month in many coastal cities,” he said.

Credit Suisse

Click above to enlarge image

Although there is no reliable data on the size of China’s grey market, the banking regulator estimates that it could be about Rmb3,000bn. Tao believes it could be as much as Rmb4,000bn, or 8 per cent of the formal lending market. It’s growing 50 per cent y-o-y, he said.

Property developers account for 60 per cent of the grey market, while SMEs make up the rest, according to Credit Suisse. But the pain — should the ‘time bomb’ explode — would be felt across all sectors, affecting corporate balance sheets, consumer confidence and even the banks’ asset quality, Tao said.

Already, the Wenzhou government is cracking down on “runaway bosses” — those who attempt to flee the city to avoid loan sharks and banks. At least 80 businessmen in Wenzhou have gone into hiding or declared bankruptcy to invalidate more than Rmb10bn in debt from the grey market, according to China Daily.

It is unclear if the new measures will do much to help: so far, pressuring the big banks to lend to SMEs has proven futile. Mid-sized banks such as China Minsheng Banking Corp and China Merchants Bank have tried to fill the gap by lending more to SMEs, but the uncertainties facing smaller companies are making smaller banks more vulnerable should SMEs go bankrupt.

Further, as we’ve previously reported, China’s main priority is to rein in inflation and cool the property sector. And it’s unlikely policymakers will ease monetary policy any time soon, analysts said.

If that’s the case then expect more pain for China’s SMEs. Look no further than Wenzhou for signs.

SOURCE: http://tilt.ft.com/#!posts/2011-10/31576/chinas-grey-market-time-bomb

Silas Berry – asiacosnult.org

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