Private lending thrives under China credit clampdown

BEIJING (Reuters) – While other businesses chafe under China's restrictions on bank lending, Gong Chengwei sees a windfall.

"For us, the credit controls are good news," said Gong, a peasant-turned-entrepreneur who runs Beijing GQWY Investment & Guaranty Co, which offers short-term loans to cash-starved small businesses and individuals.

"Many companies are short of money and they want to expand. Big companies need big money, and small companies need small money," he said.

This is the gray market in Chinese banking of semi-legal, largely unregulated, small-scale loan firms. It has taken on far greater importance in recent months, offering crucial cash lifelines as China tightens monetary conditions but also exposing serious distortions in the nation's financial system.

Companies, particularly those in the private sector, have been feeling the pinch from the government's sustained policy moves to curb inflation and its orders to banks to rein in loans.

For Gong, 36, who came to Beijing in 2001 from the central province of Hubei and initially worked as a driver, that means business has been brisk, even though his interest charges are well above official bank rates.

While banks may take up to three months to grant a loan, Gong and other gray-market lenders can give cash within a day to borrowers with sound credit records.

"Getting this loan was much easier, and it can solve our problems. We simply can't wait for bank loans," said Zhang Kaoyan, manager of a firm selling medical equipment who had just borrowed from Gong.

There is little data about the volume of gray market lending.

In a report earlier this year, the central bank estimated that private loans stood at about 2.4 trillion yuan ($365 billion) at the end of March 2010, accounting for 5.6 percent of the nation's total lending. All indications are that such lending has gone up sharply since then, analysts said.

DISTORTIONS

The need for private lending highlights deep flaws in the Chinese financial system. The government has maintained tight controls on banks, even as the private sector thrives in liberalized parts of the economy, from exporters to restaurants.

This contrast has become starker in recent months. With the central bank raising required reserves to a record high for big banks and using punitive measures to further curb loans, state-owned lenders have become much more cautious.

Analysts say they have fallen back on an old habit of issuing loans mainly to preferred customers: their peers in large state-owned enterprises. They see private firms as too risky a proposition because they lack government backing.

But it is private companies, many of which are smaller, that have been the vital force behind China's economic ascent of the past 30 years.

This has fueled demand for informal loans, particularly in the fast-growing costal provinces of Zhejiang, Jiangsu and Guangdong, where the private sector is at its strongest.

"It's an inevitable outcome of the macro-economic controls because companies cannot get loans from formal channels, and they can easily get informal loans by paying higher interest rates," said Jun Ma, economist at Deutsche Bank in Hong Kong.

It is illegal for lenders to charge more than four times the benchmark borrowing rate set by the central bank. In practice, however, the law is flouted by those offering short-term credit.

Informal lenders now typically charge 2-3 percent per month on short-term loans, implying annual rates five times the official benchmark lending rate, now at 6.06 percent.

Li Xiaoyue, an executive at Huafeng Shenyin Guarantee Co., a small lender in Wenzhou, China's hub of gray market banking, said informal lending rates in the free-wheeling city in Zhejiang province had more than doubled in the past year.

An index used by China Essence Securities to track private lending rates hit 87 in February, the highest since January 2010.

Pawn shops have also joined the gold rush. In the southern boom town of Shenzhen, they charge 4 percent per month on loans secured by property and 4.6 percent on loans backed by vehicles, according to the official China Securities Journal.

"MIRACLE"

Many local governments have encouraged the establishment of small lending firms, which usually pool money from individuals and companies, to help spur their local economies.

China's negative real interest rates, caused by rising inflation, have also encouraged people to seek riskier and higher-yielding alternatives to bank deposits.

A recent survey by the central bank's Wenzhou branch showed that 89 percent of households and 57 percent of firms in the city were engaged in underground lending.

The government has previously pledged to fully legalize the informal lending sector, but it does not appear to be in any rush. Wu Xiaoling, a former deputy governor of the central bank, said last week that small lenders were relatively safe compared with banks.

"Because they don't take deposits like commercial banks, if they go bankrupt, they will not harm the public interest. In that sense, we don't need strict supervision of the small lending companies," said Wu, now a senior lawmaker.

Gong, who declined to reveal his personal fortune as well as his firm's profitability, fears the government will eventually take action to consolidate the nearly 2,000 small lenders that have mushroomed across the country in recent years.

There have been media reports of disputes and lawsuits involving smaller lenders and pawn shops.

To avoid a crackdown, Gong said he might turn his firm into a formal commercial bank. That could happen within five years, he said.

"I think we can make it. I was a laborer when I first came to Beijing, but now I'm a boss," he said.

"That's a miracle and I'm a person who believes in miracles."

($1=6.568 Yuan)

(Editing by Simon Rabinovitch)