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[Tvoivozhd <tvoivozd AT infionline.net>]

All things considered, I would rather deal with my choice of ten 
thousand small "banks" than with a handful of REAL loan sharks (your 
friendly U.S. monopolists---OUR loan sharks who are in a frenzy to 
impose highly creative costs on borrowers, which have no relationship to 
credit-card lending costs. They don't want to make small loans to 
startups anyway---it's wonderful if you don't have to waste time and 
effort on our monopolistic, over-mergered banks, except to maintain a 
payroll account.

Yes, there is some danger to dealing with a small fringe such as our 
domestic Mafia used to be, but by and large the current Mainland China 
"street lenders" are identical to those I saw in Taichung, Taiwan when I 
lived there around 1985.  Then, the most rapid economic expansion in the 
world was fueled by factory workers' savings from their wages---in 
Taichung alone over 15,000 new factories in five years making a wild 
variety of metal, plastic, rubber, glass and fabric products so fast you 
had to bribe port workers to get your own merchandise on a container 
ship heading for the U.S.

Then, in Taiwan, any small street-stall startup which needed expansion 
capital, used to put a sign in the window stating how much they needed, 
and what they wanted to pay for it---off-duty factory workers, with 
their savings tucked in their trousers, would stroll by, read the sign, 
and go into the shop to see with their own eyes how well the shop was 
doing, talk with the owners, inspect the records, and make their 
decision whether to loan the companyt their hard-earned savings., or to 
meander on to look for a better prospect for their small investment 
funds.  The objective of every worker of course, was to accumulate 
enough wages and investment interest, to go into business for 
himself---:"TRICKLE-UP" at its heroic best.
The New York Times
------------------------------------------------------------------------


         November 9, 2004


   Informal Lenders in China Pose Risks to Banking System

*By KEITH BRADSHER*

WENZHOU, China, Nov. 3 - The Wenzhou "stir-fry" is not a dish you eat. 
But it is giving indigestion to Chinese regulators and could prove 
troublesome to many investors worldwide - from New York money managers, 
Pennsylvania steel workers and Midwestern farmers to miners in Australia.

Here in this freewheeling city at the forefront of capitalism in China, 
the dish is prepared when a group of wealthy friends pool millions of 
dollars worth of Chinese yuan and put it into a hot investment like 
Shanghai real estate, where it is stirred and flipped for a hefty profit.

The friends often lend each other large amounts on the strength of a 
handshake and a handwritten i.o.u. Both sides then go to an automated 
teller machine or bank branch to transfer the money, which is then 
withdrawn from the bank. Or sometimes they do it the old-fashioned way: 
exchanging burlap sacks stuffed with cash.

The worry for Chinese regulators is that everyone in China will start 
cooking the Wenzhou stir-fry and do it outside the banking system. In 
the last few months, borrowing and lending across the rest of China is 
looking more and more like Wenzhou's. The growth of this shadow banking 
system poses a stiff challenge to China's state-owned banks, already 
burdened with bad debt, and makes it harder for the nation's leaders to 
steer a fast-growing economy.

The problem starts with China's low interest rates. More and more 
families with savings have been snubbing 2 percent interest on bank 
deposits for the double-digit returns from lending large amounts on 
their own. They lend to real estate speculators or to small businesses 
without the political connections to obtain loans from the banks. Not 
only is the informal lending rate higher, but the income from that 
lending, because it is semilegal at best, is not taxed. For fear of 
shame, ostracism and the occasional threat from thugs, borrowers are 
more likely to pay back these loans than those from the big banks.

Tao Dong, chief China economist at Credit Suisse First Boston, 
calculates that Chinese citizens withdrew $12 billion to $17 billion 
from their bank deposits in August and September. The outflow turned 
into a flood last month, reaching an estimated $120 billion, or more 
than 3 percent of all deposits at the country's financial institutions.

If the bank withdrawals are not stemmed in the months ahead, Mr. Tao 
warned, "this potentially could be a huge risk for financial stability 
and even social stability."

With China now accounting for more than a quarter of the world's steel 
production and nearly a fifth of soybean production, as well as some of 
the largest initial public offerings of stock, any shaking of financial 
confidence here could ripple quickly through markets in the United 
States and elsewhere. For instance, if the steel girders now being 
lifted into place by hundreds of tall cranes in big cities across China 
are no longer needed, that would produce a worldwide glut of steel and 
push down prices.

On Oct. 28, when China's central bank raised interest rates for one-year 
loans and deposits by a little more than a quarter of a percentage 
point, it cited a need to keep money in the banking system. Higher 
official rates should "reduce external cycling of credit funds," the 
bank said in a statement.

The main Chinese banks have fairly substantial reserves, but they need 
those reserves to cover huge write-offs of bad debts someday. The 
International Monetary Fund's China division chief, Eswar Prasad, 
expressed concern about bank withdrawals in a speech in Hong Kong three 
days before the central bank acted.

The hub of informal lending in China is here in Wenzhou, 230 miles south 
of Shanghai. Some of China's first experiments with the free market 
began here in the late 1970's, and a result has been a flourishing 
economy together with sometimes questionable business dealings.

Depending on how raw they like their capitalism, people elsewhere in 
China describe Wenzhou as either a center of financial innovation or a 
den of loan sharks. But increasingly, Wenzhou is also a microcosm of the 
kind of large-scale yet informal financial dealings now going on across 
the country.

The withdrawals by depositors and the informal money lending have spread 
so swiftly here that it is only in Wenzhou that the Chinese central bank 
releases monthly statistics on average rates for direct loans between 
individuals or companies. The rate hovered at 1 percent a month for 
years until April, when the authorities began limiting the volume of 
bank loans.

Borrowers default on nearly half the loans issued by the state-owned 
banks, but seldom do so here on money that is usually borrowed from 
relatives, neighbors or people in the same industry. Residents insist 
that the risk of ostracism for failing to repay a loan is penalty enough 
to ensure repayment of most loans.

Although judges have ruled that handwritten i.o.u.'s are legally 
binding, creditors seldom go to court to collect. "If it is a really 
good friend, I would lose face if I sued them in court," said Tu 
Shangyun, the owner of a local copper smelter and part-time "silver 
bearer" - a broker who puts lenders and borrowers in touch with each 
other, "and if it weren't a good friend, I wouldn't lend the money in 
the first place."

Violence is extremely rare, but the threat of it does exist as the 
ultimate guarantor that people make every effort to repay debts. 
"Someone can hire a killer who will chase you down, beat you up and 
maybe even kill you," said Ma Jinlong, who oversaw market-driven 
financial changes in the 1990's in Wenzhou as director of the municipal 
economic reform committee and is now an economics professor at Wenzhou 
University.

An austerity policy was invoked, its goal to slow rapid economic growth 
in the hope of stopping an upward spiral in the inflation rate. With 
consumer prices rising at 5.2 percent a year despite price controls on 
many goods and services, and with less-regulated prices for goods traded 
between companies climbing nearly twice as fast, people lose buying 
power while their money is on deposit at a bank.

The interest rate for informal loans jumped last spring to 1.2 percent a 
month, or 15.4 percent compounded over a year, and has stayed there 
since. According to the nation's central bank, total bank deposits in 
Wenzhou have been dropping by $250 million a month since April as 
companies and individuals withdraw money either because they can no 
longer obtain bank loans for their investments or because they want to 
lend the money at higher rates to each other.

For lenders, these interest rates are much more attractive than earning 
a meager 2.25 percent a year, even after the recent rate increase, on a 
deposit at a government-owned bank. And while Beijing assesses a 20 
percent tax on all interest from bank deposits, nobody pays tax on the 
income they receive from lending money on their own, Mr. Ma said.

Most informal loans have traditionally gone to relatives or neighbors to 
finance the starting of small local businesses. Wenzhou is now one of 
the world's largest producers of nonbrand sunglasses; Dong Ganming, the 
owner of a 350-employee sunglass factory here, said that his plant was 
just one of almost 1,000 here involved in making glasses.

Fierce competition has prompted local residents to borrow money to 
exploit every possible niche in the industry, with some factories making 
nothing but bridges for sunglasses so that they will not slide down 
customers' noses, other factories making only the lenses and so forth. 
Any government crackdown on informal loans would carry the risk of 
stifling highly efficient small and medium-size businesses that have 
little hope of obtaining loans from the state-owned banks, which still 
allocate credit based partly on political connections.

Mr. Dong said that loans from friends and family allowed him to start 
his sunglass company with 10 employees a decade ago; he quickly paid off 
the loans and has been reinvesting most of the profit ever since, 
putting very little into bank deposits. "The interest in the bank is 
very low," he said. "If you invest the money, you can get much more money."

But more recently, local residents say, a lot of money has been flowing 
into real estate here and in other big cities, especially Shanghai, 
helping to fuel double-digit increases in interest rates. Deals 
increasingly involve people who have no family or neighborhood 
connection, raising the risk of disputes.

Kellee Tsai, a specialist in Chinese informal banking at Johns Hopkins 
University, said that many overseas emigrants from Wenzhou had also been 
sending their savings back to be lent at much higher rates here than are 
available in the countries they have moved to.

Some local investors have been able to pay for their investments with 
profits from businesses here, like Chen Shen, the owner of four shops 
that sell shoe-manufacturing equipment to the hundreds of shoe factories 
that have popped up in this area. She said she paid cash for an 
apartment near Shanghai's Bund, its riverfront district, that had 
appreciated as much as 60 percent in less than two years.

Still, Chinese regulators do not like the practice, and officials have 
been trying to stamp out such operations with limited success. They have 
outlawed the practice of pooling savings into various kinds of informal 
banks that make loans for real estate and other investments: organizers 
are subject to the death penalty but are rarely caught unless the 
informal banks collapse.

Oriental Outlook, a Chinese current affairs magazine, reported late last 
month on the trial of a man accused of operating an illegal bank 
northeast of here that collapsed a year ago, leading to the filing of 
more than 200 civil suits. Another man who lost money in the scheme, and 
went bankrupt as a result, assaulted the defendant outside the 
courtroom, the magazine said.

The extent of such pooling is unclear. But it poses the greatest risks 
of damage to financial confidence if bank runs occur at these informal 
institutions, economists agree. Bank runs, with depositors lined up 
clamoring for their money back, have been an occasional problem around 
China for years, but always quickly contained as the authorities rushed 
to distribute as much cash as necessary.

"The policy with bank runs, even with illegal banks in some cases, has 
been to flood the bank with liquidity and pay everyone off," said 
Michael Pettis, a finance professor at Beijing University, who 
criticized as ill advised the Chinese policy of bailing out even illegal 
banks. "One of the most salutary ways to let people know not to put 
money in these is to let two or three go bankrupt."


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