China's New Lenders of Last Resort

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China's New Lenders of Last Resort

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By LINGLING WEI

 

WENZHOU, China—Dai Weidong's gold-plated cellphone has been ringing off the hook lately with local entrepreneurs looking for financing help.

 

But Mr. Dai, as his choice of phone suggests, is not a conventional banker. He is a member of a fast-growing sector that has sprung up through the cracks in China's state banking system: private guarantors who offer to help small-and-medium-sized enterprises get bank loans by pledging to repay the loans if borrowers default. They also lend directly to credit-starved businesses, or invest in them.

 

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Guarantors have become the lenders of last resort to small manufacturers who increasingly are getting squeezed by tight credit as well as soaring wages and other production costs. These private operators, using money raised from property developers, coal miners or other cash-rich individuals, aim to fill the funding void left by state banks that many say have all but stopped lending to small businesses. In return, they charge their clients a fee on top of high interest rates imposed on the loans.

 

As of the end of June, about 287.5 billion yuan ($45 billion) of loans were arranged by 3,366 nonbank institutions specializing in small letters of credit, according to official data. By comparison, 124.9 billion yuan of loans were issued by 1,940 such firms a year earlier. Industry experts say the actual figures are much larger, because not all of the private lending is reflected in the official statistics.

 

But these firms are lightly regulated, critics say, and many traditional banks refuse to do business with them.

 

China today has become what many call a two-track economy, with a state-owned sector flooded with cash and a private one starved of funding. The financial woes of the private sector could have an impact on Chinese growth: By some analyst estimates, it includes some 40 million companies and accounts for 80% of the country's jobs and more than half of economic output.

 

For years, the Chinese leadership has sought to encourage private entrepreneurship as a way to boost employment and domestic income. Deng Xiaoping, the late leader who started China's economic reform in the late 1970s, famously declared: "Getting rich is glorious."

 

But even as the private sector has expanded, large state-controlled enterprises have remained the focus of Chinese policy makers, especially in times of crisis. At the end of 2008, when the world economy started to wobble, Beijing responded by pumping in some $586 billion of credit to keep its economy humming at a rate close to 10% a year. Most of that money, though, has gone to railways and other state-run projects.

 

China's big banks, led by Industrial & Commercial Bank of China Ltd. and China Construction Bank Corp., posted record profits in the first half of this year, buoyed in part by a greater focus on business that generates fee income, such as credit cards and wealth-management products.

 

While some of the large banks reported bigger small-business lending volumes, many private companies—particularly small manufacturers—say credit overall has remained tight and expensive since the central government started tightening bank lending last year to contain inflation spurred by the massive investment stimulus.

 

Already, funding problems have pushed into bankruptcy a few small manufacturers in coastal provinces Guangdong and Zhejiang, the traditional hubs for China's private economy.

 

Credit guarantors like Mr. Dai often work in conjunction with banks by taking on the risk of a loan from a bank to a small business in exchange for a fee—anywhere from 1% to 10% annually of the loan amount. Interest rates on these loans in places like Wenzhou have surged to as high as 15%, or twice the benchmark lending rate.

 

In 2007, Mr. Dai gave up a manufacturing business he had run for years and switched to credit guarantee, a change of course he jokingly calls "prescient" in light of the funding plight facing small manufacturers now. His firm, Jinmao Guarantee Co. Ltd., was registered with the Wenzhou government with 30.2 million yuan ($4.7 million) in capital, mostly his own.

 

Describing himself as a "bridge" between small businesses and banks, Mr. Dai arranges loans from banks to his business clients by pledging to repay the loans if his clients can't. Mr. Dai charges his clients a 0.1% monthly fee, or 1% a year, for every loan guaranteed by his firm. To control risk, he only provides guarantees for companies that are willing to put up their hard assets such as machinery, as collateral for the loans.

 

 

Jinmao Guarantee hasn't had any delinquent loans in the past four years, Mr. Dai says. However, even with the guarantee and the collateral, he says, many banks are still unwilling to lend to small businesses.

 

"I want to make it big, but banks have no money," Mr. Dai says, referring to the sharply raised reserve requirements on Chinese banks that have limited their lending ability to only 78.5 yuan for every 100 yuan in deposit.

 

The potential high returns on private funding, in turn, have made the credit-guarantee business an attractive investment for the ample amount of cash floating around China. And because these firms are not deposit-taking institutions, they aren't subject to the same regulatory scrutiny as banks.

 

"Regulation is very weak, opening doors for fraud and the flow of capital into the very sectors the government is trying to rein in, like real estate," says Zhang Yi, a regional sales manager at BOC Fullerton Village Bank, a joint venture between Bank of China Ltd. and a unit of Temasek Holdings, a Singaporean sovereign-wealth fund.

 

The venture, representing the growing interest among foreign investors in providing small-business financing in China, plans to open up to 400 rural banks in rural China in the next five years. Zhu Chaoping, head of research at ChinaScope Financial, a market-research firm in Hong Kong, noted that credit-guarantee firms in China are supposed to be supervised by governments of the regions where they are registered. "But local governments usually lack the skills and experience needed to secure the stability of the lending system," he said.

 

Still, in Wenzhou alone, where residents have been blamed for pushing up housing prices during the boom times, the number of guarantee companies has expanded dramatically in recent months, to over 200, according to official and industry estimates.

 

"The investment of choice for people in Wenzhou is no longer real estate," says Zhou Dewen, deputy director of the China Association of Small- and Medium-sized Enterprises, who lives in Wenzhou. "It is credit guarantee."