Oct 11, 2011 02:36 PM

Cash Crash for Wenzhou's Private Loan Network

Dubbed the nation's capital of private financing, the city of Wenzhou offers a textbook example of how non-bank lending has fueled private sector prosperity – and risk-taking – in China.

A recent central bank survey said about 60 percent of all local businesses and the vast majority of households are interconnected through the city's private lending system.


It's a tight financial network that interweaves lenders and borrowers collectively, often to their mutual benefit and sometimes to their terrible loss.

If only a few debt-ridden companies collapse because they can't afford to repay the high-rate, short-term loans they've gotten from private lenders in the network, the ensuing financial trouble can ripple through the entire credit-connected community, exempting few from turmoil.

Since early this year, according to the Wenzhou Public Security Bureau, some major Wenzhou-area private company owners have fled creditors to avoid repaying loans. In each of these cases, though, the system survived relatively unscathed, and community dealmaking continued.

Yet a serious, domino-effect of financial trouble started to endanger the entire system in July after a well-known entrepreneur named Wang Xiaodong disappeared. A local banker familiar with the case said Wang abandoned a venture capital investment company he owned that owed up to 1.2 billion yuan to private lenders.

Wang's story points to the fact that Wenzhou residents are far more enthusiastic than people elsewhere in China about private lending. A survey by the central bank's local branch found 89 percent of the city's families and 60 percent of local enterprises were involved in private financing.

The Wenzhou Economy and Trade Committee, a government regulator for local trade and economic development, estimates outstanding private lending by city residents and enterprises reached a total 120 billion yuan by the end of June. And interest rates on these loans far exceed the 7-8 percent banks charge for standard borrowing in Wenzhou.

"Sometimes, annual interest rates are as high as 60 percent" for private loans, said Shi Xijian, secretary-general of the Wenzhou Banking Association.

Wang borrowed money at high rates from local enterprises such as shoe manufacturer Jubang Footwear Co., which fronted him 50 million yuan at a 24 percent annual interest rate.

The amount Wang owed Jubang when he fled was just a fraction of his total outstanding debt, the banker said, which had climbed to 1.2 billion yuan as of last summer. Indeed, Wang's company was paying up to 24 million yuan a month just to service its debt.

Since Wang defaulted, private lenders across the city have been demanding immediate paybacks from clients, prompting many borrowers to flee. As of September 27, more than 40 indebted local business owners had gone into hiding, according to the Wenzhou Public Security Bureau.

How Defaults Spread

What did Wang do with all that borrowed cash? Most of the capital was invested in property development and the Shanghai stock market, the banker said. Moreover, he was a private lender in his own right, once reportedly loaning 19 million yuan to an unidentified entity.

How did he get in trouble? Wang lost his Midas touch after property and stock markets started slowing in China early this year. It soon became apparent that he would need a miracle to avert default, the banker said, so he gambled on a risky futures market. He lost the bet, then slipped out of public sight.

Sources estimate Wang still has assets worth as much as 6 billion yuan. They also say he's made secret moves toward settling with at least some creditors.

A government official in Wenzhou's Ouhai District told Caixin that Wang snuck back into town in early September and offered to repay some lenders at a 30 percent discount. "Some have accepted the settlement," the official said.

But today, settlement offers would be too late for some companies such as Jubang, which suspended production after its owner Wang Hexia fled July 27 in the wake of Wang's default.

According to local officials, Jubang's owner borrowed money from private lenders at an 18 percent interest rate and then loaned that cash to Wang at a higher rate.

These lenders included low-level government workers who routinely conducted financial deals on the side, leveraging special government access to banks.

"Wang kept a list of private lenders, and a large proportion of the names on that list were civil servants," said the bank official.

A number of enterprises linked to Wenzhou's private credit community have been affected by these and related defaults, according to a Caixin investigation. Some were forced to shutter factories after being caught between borrowers and creditors.

Wenzhou government officials have investigated some of local enterprises threatened by the spreading default. They've also discussed the situation with business owners and economic development officials at meetings attended by Caixin.

Yu Zhongping, head of the Wenzhou economy committee, noted at one meeting held in late September that the recent string of company failures had nothing to do with business conditions, since customer orders were strong at many factories that suddenly closed.

Cash Churn

Many sources interviewed by Caixin blamed the ripple effect of financial trouble in Wenzhou on certain non-financial enterprises that, in search of easy money, borrowed from banks or private lenders and then re-loaned that money to other firms or speculators at higher rates.

The bank source said these money churners included enterprises with good credit records as well as civil servants and bank employees.

Government and bank workers have special access that lets them borrow from banks at low rates. "The higher the administrator is in the ranks, the greater the amount of bank loans" can be obtained, he said.

The system also includes about 48, government-approved loan guarantee firms in Wenzhou operating as of September. Some of these firms also handled what they called wealth management products for investors, and acted as middlemen between borrowers and private lenders.

In many cases, said a financial researcher, guarantee firms are seen as private financing intermediaries who help facilitate private lending.

Another, even bigger branch of the private lending tree is comprised of non-licensed financial platforms. Some local officials estimate that more than 1,000 organizations are functioning as unauthorized platforms for private lending in Wenzhou.

Regulatory authorities struggle to supervise these activities, said Cheng Hengxiang, secretary-general of the Wenzhou Credit Guarantee Association, since the private lending tradition is deeply embedded in Wenzhou's business community.

And facets of the business have changed over the years in ways that enhance risk. For example, the financial researcher said, personal relationships between private lenders and borrowers encouraged repayment rather than face-losing default.

But in recent times, by working through intermediaries, the researcher said, lenders and borrowers have become more isolated, creating a business atmosphere marked by higher default risks.

Without relationships lubricating credit deals, some unscrupulous intermediaries have spread risk by, for example, withholding information from a lender about a potential borrower's credit record.

Owners of two loan guarantee firms that obtained operating licenses last May were among those who took flight after Wang's default triggered the default wave. Some investors told Caixin these companies owe millions of yuan to private lenders.

Some lenders that wrote high-rate loans got their money illegally through the Lucheng Rural Cooperative Bank, authorities said.

In late September, private lender Chen Fanrong allegedly tried to raise money to repay debts by collaborating with the cooperative bank's chief in a scheme to trick more than 40 customers into borrowing more than 20 million yuan combined.

The customers' money went to Chen, who then disappeared, said a bank official who declined to give his name. A criminal investigation is under way.

Bank clients said they were encouraged by Chen to sign up for preferential bank services and didn't realize they'd signed loan contracts until it was too late.

"I never showed up to withdraw or transfer money, but all of a sudden I owe the bank 300,000 yuan," said one of the fooled customers.

"It's common for a loan shark to risk everything when desperate," said a person familiar with private lending in Wenzhou.

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