Guaranteed trouble

Troubled borrowers are causing financial contagion in Zhejiang

Guaranteed trouble

Bad loans seem to be spreading fast in Zhejiang province

In December 2011, the Jiangsu branch manager at a little-known construction company, Zhejiang Tianyu, was arrested for illegal fundraising.

The company’s assets were frozen by the court, which triggered a wide-ranging chain reaction across the province. One affected manager described it as a “financial SARS,” reports South Weekend.

The contagion started when eight banks asked furniture company Carleo Group to repay Rmb115 million ($18 million) worth of loans.

Carleo Group had a mutual guarantee with Tianyu, which means that both companies had agreed to take liability for the other’s loans in event of default. This a common arrangement in Zhejiang, and multiple companies have joined together to take shared financial responsibility.

So when Tianyu got into trouble, bank managers went knocking on Carleo Group’s door for the cash.

A month later, another furniture company, Rongshi Group, was asked to pay Rmb30 million of loans belonging to the Carleo Group, due to a mutual guarantee agreement.

The demand triggered similar arrangements elsewhere, affecting larger and larger companies before reaching Hupai Holdings, an electrical equipment manufacturer, and one of China’s top 500 private enterprises, with more Rmb3.5 billion in assets.

Banks have been hounding Hupai to pay up on outstanding loans for months, pushing the company close to bankruptcy, reports Caixin.

The magazine said that 62 companies – across a wide range of industries – have now been affected by Tianyu’s collapse, forcing provincial officials to convene a meeting in June with local businessmen and bankers.

Although the details of the meeting were not made public, it is thought that officials might offer bridge loans to companies caught up in the web of debt. These would be used to repay outstanding debt as long as the company concerned is able to stay in business as a result.

The problem is that, regardless of the scheme, jittery banks and are now trying to claw back other loans where similar guarantee structures have been used.

This is because bank managers are suddenly concerned that if the level of bad loans becomes too high, their jobs will be on the line. Some banks have even been experimenting with a mechanism where lending officers are forced to stump up some of their own money (as a deposit) when they approve a corporate loan, reports South Weekend.

In the current circumstances that means that there is a strong incentive for bank managers to call in outstanding loans – worsening the cash-crunch. WiC has written extensively about debt defaults, particularly among struggling private sector firms (see WiC109 for one example). Many of the stories have come from the city of Wenzhou, also in Zhejiang. But the Tianyu case demonstrates that similar cases are spread much more widely, including the provincial capital, Hangzhou.

As Patrick Chovanec, a professor at Tsinghua University, recently posted on his blog: “Shadow banking, and the risks it hides, is pervasive across China’s economy. If you’re still buying the line that what happened in Wenzhou has no relevance to the rest of China, I have a couple of high-speed rail lines I’d like to sell you.”

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