Shadow bankers

Poorly policed system

“Welcome to the home of one of China’s 10 most vital economies: Wenzhou. Here in the pioneering hometown of ‘Daring Trailblazers, Harmonious Citizens’, the Wenzhou City Municipal Communist Party Committee sincerely hopes that you find friendship, business opportunities and success.”

That’s the text message that appears on your mobile phone whenever you land in Wenzhou, notes Peter Hessler in his book Country Driving. In many parts of the world it might seem oxymoronic for a Communist Party Committee to wish you success with your business opportunities. Not in Wenzhou – which is far and away the most capitalist of China’s cities.

“All across China the people of Wenzhou are famous for their entrepreneurial skill,” writes Hessler. “Over 90% of the Wenzhou economy is private – unlike other parts of the nation, state-owned industries have played little role in local development.”

Part of the reason is geographic. Wenzhou is a coastal city – cut off from the rest of China by mountains. Thanks to its proximity to the Taiwan Strait it was deprived of industrial investment during Mao Zedong’s rule – leaving it bereft even of rail connections.

Throughout its history it had been a vibrant port, and its people focused on trade. So when Deng Xiaoping began the process of ‘reform and opening’ in 1978, it was no surprise that Wenzhou’s local entrepreneurs were the first to pounce on the opportunity, setting up the country’s first private companies.

With few natural resources or advantages to speak of, Wenzhou became a remarkable success – today there are volumes of books in Chinese airport shops with titles like The Collected Secrets of How Wenzhou People Make Money. Among other things, the city produces 70% of the world’s cigarette lighters and a quarter of the shoes worn in China.

Lacking funds from state-owned banks, the Wenzhou entrepreneurs also pioneered informal lending techniques – where one boss, for example, might loan money to another to open a factory. This style of private lending has since spread across the whole country – with no one knowing for sure how big the ‘shadow’ banking sector has become.

In a recent survey, the central bank has tried to figure it out – or at least, it has made a start – by going back to the place where the practice originated: Wenzhou. According to the 21CN Business Herald, the local Wenzhou branch of the People’s Bank of China was tasked with uncovering the scale of the city’s private lending market last month. It came up with a specially selected sample of 140 companies and 120 households that it deemed representative, and interviewed them. It then used the results to come up with some rough estimates.

So what is the size of the ‘unofficial’ loan market in China’s most entrepreneurial city? The central bank calculates that it is Rmb56 billion ($8.19 billion) – with personal loans between individuals comprising Rmb43.2 billion and loans made by companies the remainder.

With the recent clampdown on bank lending, the rates charged for loans have risen significantly, reports the survey. Private lending rates in Wenzhou fluctuate between 11% and 14.5% – i.e. multiples of official lending rates.

The newspaper adds that 89% of the households surveyed admitted they participated in the flourishing private lending market, and 57% of companies. Of the six largest companies sampled, only one made private loans – the survey found that small and medium-sized enterprises were much more active (60% did so). And the style of lending remains as basic as it was when the first Wenzhou entrepreneur offered to loan money to another. The survey discovered that 78.8% of private loans (made by individuals) are unsecured and based merely on an ‘IOU’. For companies the percentage wasn’t much smaller at 70.58%.

So how do these loans fare? The survey found that companies recovered 95.95% of their loans in full; but for individuals the recovery rate was only 74.16%.

By any definition, this is risk capital at its rawest – and if the central bank’s survey is to be believed, the size of this shadow banking market is much bigger than most official estimates. In Wenzhou – the only place so far surveyed – it was twice as large as the previous official guesses.

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