Subject: [Homestead] Street loans in China vs. Bank loans
Date: Tue, 09 Nov 2004 08:25:06 -0800
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."