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 The domain of loan sharks, underground lending is the least
regulated area of China's shadow banking, or non-banking, sector and
for some it is seen as the biggest risk to China's financial
stability.
It connects China's army of wealthy savers with mostly small
borrowers unable to access normal lending and who can end up paying
exorbitant annual interest rates of 100 percent or more.
At 8 percent of China's $9.4 trillion economy, according to IMF
estimates, it is a surprisingly large niche.
As China intensifies its efforts to discipline risky lenders and
calm exuberant credit growth, financial stress is building in the
country and underground debt is becoming one of the biggest banking
risks.
Analysts say the underground market is most vulnerable to worrying
spikes in unpaid loans, especially since its borrowers are often
small-time exporters hardest hit when the economy stutters.
"You may see a high frequency of defaults," said Qiang Liao, an
analyst at Standard & Poor's in Beijing. "The borrowers are more
vulnerable to an adverse economic environment."
The risk is that a major default of an underground loan could
trigger a domino effect threatening the wider financial system.
Such dangers were highlighted this month when an investment trust
teetered on the verge of a default after raising funds to make a
loan to a struggling coal company, which had also borrowed from loan
sharks. The coal company has collapsed amid falling coal prices,
with the high rates on its underground loans contributing to its
downfall.
Among anecdotal evidence of the growth in loan sharking, media
reports said Inner Mongolia saw an "explosion" in the number of
court disputes over underground loans last year at over 43,000.
In Jiangsu in south China, businesswoman Gu Chunfang was sentenced
in October to effective life in prison for illegally amassing 1.8
billion yuan with promises of annual returns of 40 percent. Some of
the money was invested in coal mines.
"When I look at the figures for the money I've borrowed, I feel
uncomfortable and pressured, so I rather not look," Gu was quoted by
the International Finance News as saying, when she explained why she
had stopped keeping accounts.
Gu was undergoing plastic surgery on her face to alter her looks and
evade the police when she was arrested, the paper said.
FAST LIFE AND FAST CARS
Analysts believe the underground market, which most estimate is
worth around 3 trillion yuan to 4 trillion yuan, is one of the major
sources of funding for shadow banks.
But any assessment of what underground lenders get up to are
intelligent guesses at best. Information is hard to come by and how
much money is involved is not really known. Likewise, where the cash
goes after it is raised is also not clear.
When China tightened credit controls in 2011, the sector was thrust
under the spotlight after dozens of company bosses from Wenzhou
city, known for its private enterprise, fled town to avoid repaying
their underground loans.
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Wu Ying, probably China's best known underground lender who was
jailed for life in 2012 for cheating investors of 380 million yuan
by offering returns as high as 180 percent, was said to have
invested in over 700 shops and 20 cars, including four BMWs and a
Ferrari.
"Informal lenders are the least transparent of the actors in
China's shadow banking system," the IMF said in a report in October
2012, adding that they challenge financial stability.
The spotlight has been on loan sharks previously. More than 10,000
people reportedly blocked a train station in central Hunan province
in 2008 after a local loan shark scheme lost some 620 million yuan
of their cash.
DEADLY RATES
China's overall debt has ballooned in recent years. The ratio of
total debt-to-GDP, including government, corporate and household
debt, was set to reach 218 percent of GDP by the end of 2013, up 87
percentage points since 2008, rating agency Fitch estimated last
year.
China's efforts to bring the growth under greater control ironically
quickened the rise of shadow banks, which thrive on the thirst for
cash and a desire among savers for sterling returns.
With China's one-year deposit rates at 3 percent and scarcely above
annual inflation, many savers succumb to the promise of fat
investment returns.
Estimated by Standard & Poor's to account for $3.7 trillion of
lending, or a third of all bank loans, the growing might of shadow
banks has raised fears that they might imperil China's financial
stability with their looser lending standards, especially at a time
when years of breakneck economic growth is coming to an end.
"They help people to increase their leverage to unsustainable levels
at a time when their businesses are going down," said Christine Kuo,
a senior credit officer at Moody's.
Qinghai Sunshiny Mining Co Ltd knows how fatal steep rates can be.
It turned to loan sharks after it was blacklisted by banks in 2005
and owed 119 creditors 13.2 billion yuan as of September, local
media said.
Rates on some of the loans were 120 percent, or 314 percent if
interest was compounded, and Qinghai Sunshiny has since gone bust.
(Reporting by Koh Gui Qing; additional
reporting by Shao Xiaoyi in Beijing and Shanghai newsroom)
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